Archive for the ‘Investment Products’ Category

SEC’s EIA rule may resurface – Investment News

July 27, 2009

The US District Court of Appeals has ruled that the SEC cannot regulate Equity Index Annuities. The SEC may reconsider it’s approach and could justify the regulation of a product that is not a security at some point in the future, but for the foreseeable future, these products will continue to be regulated by the Department of Insurance in each state. Insurance is not federally regulated, it is handled at the state level. Either way, you should know about Equity Indexed Annuities in detail before considering purchasing one.

Annuities are a product sold by insurance companies that offer tax-deferral of any income and gains that are not withdrawn from the contract. Fixed annuities offer guaranteed principal and an interest rate that is either fixed or based on a market index. Variable annuities offer the ability to invest in sub-accounts, similar to mutual funds, that can be in equities, fixed income, cash equivalents, and alternatives such as real estate. Gains and income are not taxed until they are withdrawn from the contract. Both fixed and variable annuities are offered either as deferred or immediate contracts. An immediate annuity offers a regular income stream that is generally a fixed amount for life, a time period, or a combination of both. As an example, the payments are for ten years guaranteed and for life thereafter. In that case, the insurance company agrees to pay the purchaser an amount for ten years whether they are alive or not. If they are alive after ten years, the payments are guaranteed to continue until their death.

Equity Index Annuities(EIAs) are a type of fixed annuity. They are not a security and although they contain the word equity, you should not expect an EIA to offer performance that is similar to the stock market. In exchange for the guaranteed principal of the EIA, you give up a portion of the markets return. Many EIAs base their interest rate on a market index like the S&P 500. If the S&P 500 falls, your annuity value remains the same. If the S&P 500 gains, your interest rate will rise either as a percentage of the gain (for instance 50%) or up to a limit or cap (for instance 6.5%). It is important to understand that the index that the EIA uses to determine the interest rate only uses the principal return, dividends are not included. As a result, these contracts are not an alternative to equities but they can be a valid option for funds that might be in fixed income or bank accounts.

The problem with EIA’s is that they are very complex products. Most have high surrender charges and long surrender periods. The worst EIA’s do not allow withdrawals and must be converted to an income stream (annuitized) when you want your money back. Do not buy an EIA if your agent is unable to fully explain the product to your satisfaction. Do not work with any agent, or company, that advertises that you can get the return of the market without the risk! That will not happen!

This overview is minimal, you should go to the NAIC website and request one of their consumer guides. The National Association of Insurance Commissioners offers insurance guides for Auto, Home, Life, Long-term Care, and Annuities. Their guides are educational and not advertising. You can download some of the guides but the annuity guide must be mailed. To get yours, visit NAIC.
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SEC’s EIA rule may resurface – Investment News“>
The reporter for Investment News, Sara Hansard, asked my opinion of these products and was kind enough to include my comments and my picture in her article. To read the article, just click this paragraph or the link below.

SEC’s EIA rule may resurface – Investment News

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Leveraged ETF’s in the News – Wall Street Journal

July 23, 2009

I continue to be concerned about the use of leveraged ETF’s by retail clients. These complicated products offer the exact opposite return of an index multiplied by a factor of either 2 or 3, but this performance is only for one day. Basically, if the S&P drops 5%, an inverse ETF goes up 5%, a 2X Leveraged ETF goes up 10%, and a 3X Leveraged ETF goes up 15%. However, when these products are held beyond one day, their performance can be wildly different than what most investors would expect.

The leverage creates a characteristic that is called volatility drag. It is very similar to compounding and causes the longer term performance to be much higher or lower than the underlying index. These products have a place, but only the most knowledgeable active managers should use them. I’m not convinced that they reduce risk and believe, that for most investors, they dramatically increase portfolio risk!

Evidently, one major brokerage firm agrees. Here’s the article from the Wall Street Journal.

Finra’s ETF notice angers ICI, firms – Investment News

July 13, 2009

Finra’s ETF notice angers ICI, firms – Investment News

I recently read and reviewed Martin Weiss’s bestselling investment book, The Ultimate Depression Survival guide on Amazon. To read the review, click the link in the blogroll entitled, Paul’s Reviews of Books on Amazon.

My concern with the investment advice offered in this book is the use of leveraged ETF’s, which FINRA recently deemed unsuitable for individual investors. This article from Investment News describes FINRA’s decision and the reaction of brokers, leveraged ETF providers, and advisors. These ETF’s appear to offer a simple solution to a falling market, but they are actually very complex and require continuous monitoring. By necessity, any discussion of leveraged ETF’s is technical.

My main point is that the DIY, do it yourself, investor should avoid leveraged ETF’s and, quite frankly, I’m not sure most advisors should utilize these funds either.

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