Your Questions Answered: Equity-Indexed Annuities and Exchange-Traded Funds

Question: My husband and I spoke with a financial advisor who is a salaried employee of our credit union regarding two of our retirement accounts. I managed these accounts myself during the boom years, but feel "out of my league" in present market conditions. I really want to protect these two nest eggs and grow them over time, while my husband starts fresh in his new 401K plan. The advisor mentioned a product called the USAllianz High Five variable annuity. I've spent this evening reading mostly negative things about annuities, but we do seem to fall into the "it might be right for you if..." category, mostly because retirement is still 20 years or so off. Do you have any thoughts on this topic as it relates to us or this product in particular? My husband and I are 44 and 42 years old respectively, with two young children. We live on one adequate but modest income. Saving is second nature--if only we had a similar talent for investing! Answer: First, don't be fooled by the fact that the person you spoke to is a salaried employee of the credit union. Having worked in a bank environment, I can assure you that there is tremendous pressure on these employees to meet certain quotas. Just because the person is salaried does not mean there isn't a conflict of interest. Credit unions and banks make more money off of investments now than they do on any other banking product. By using salaried employees, the bank or credit union gets to pocket the 5-7% commission on the Allianz annuity, while the salaried advisor might only get a $50 bonus. As for the credit union’s recommendation, I am not a proponent of using annuities for IRA money. (See articles on my website.) A Variable Annuity is essential a mutual fund in an insurance wrapper. The problem is that ‘wrapper’ adds considerable costs to the equation. In most variable annuities, the underlying costs will often total 2.5-3.5% per year—or higher! Plus you are limited to the choices they give you and have no control over what choices are added or taken away. Secondly, it is important for you to remain flexible. You need to be able to change your investments and advisors without facing any surrender penalties, especially over the 20 years you have until retirement. There are ways to protect your investment from significant loss with growth potential that don’t require you to tie up your money for an extended period of time. For instance, I use a proprietary money management system for my clients. It is designed to allow them to participate in market growth while significantly reducing their potential for loss (in many cases to less than 3%). It is designed for those who want to grow their money without losing their shirt. And it does so without any commissions, surrender penalties or time commitments. Sounds like you could use something similar Question: I have heard that there is a stock that covers the Dow and protects your money better than any individual stock. I heard that this stock has all the stocks in the index, so it performs just like the Dow. What is the stock symbol and what is it selling for? Do you recommend it for long-term growth? Answer: What you are referring to is an Exchange-Traded Fund. ETFs are designed to mimic their underlying index so they give you the diversification of a mutual fund and the liquidity of a stock. There are over 150 indexes with ETFs tracking them. The symbol for the one that tracks the Dow Jones Industrial Average is DIA. There is also another one (IYY) that tracks the Dow Jones Total Market Index. Ever since the mutual fund scandal and the redemption fees added by many mutual funds, I have switched to using ETFs almost exclusively with my clients. As far as recommending them for long-term growth, that will depend on your situation. I am not a big proponent of strict buy and hold because there is too much risk of having to wait years to recover from a loss. This doesn't make sense if you are retired. Want me to personally answer your financial question? Go to www.guardingyourwealth.com and click on ‘Ask Jeff’. In addition to being a nationally syndicated columnist and Certified Financial Planning Practitioner, Mr. Voudrie provides personal, private money management services to clients nationwide.

How To React To Market Turmoil

Last week, the stock markets suffered some of their greatest losses in two years. The Dow was down 3.6% for the week, the Russell 2000 4.91% and the NASDAQ 5.18%. Many of the major averages lost close to 2% on Friday alone. How should you react when the stock market drops significantly? Read on to find out. First, let’s look at the big picture to better understand the causes of this decline. Currently, a host of mixed signals has created uncertainty over the strength of our economy. Oil prices have surged, inflation fears have escalated and economic growth has appeared to slow. Big blue chip companies such as GM and IBM have reported disappointing earnings. On the other hand, General Electric released impressive earnings figures reflecting organic growth of 10%. Citicorp and Wachovia also exceeded expectations. As usual, the signals add up to one big question mark. There are no concrete conclusions you can draw from them one way or the other. So the questions remain: has our economy hit a soft spot? Is a recession in our near future? Will inflation fears come to pass? Will the spike in oil prices spell doom for our economy? Or will all the bad news just blow- over and amount to nothing? I wish I had the answers. And the truth is, no one can say for sure. When in doubt, markets tend to focus on the negative, not the positive. Markets are very emotional and sometimes end up fulfilling their own prophecy. Individual investors are very emotional, too. And therein lies the problem. Investing shouldn’t be an emotional decision. It should be a strategic one, with a long-term course of action carefully thought out and planned for. Changes in long-term strategy should not be made because of short-term events. Unfortunately, few investors are able to detach themselves emotionally from their investments. They fall into a fear/greed cycle that not only costs them money, but also peace of mind. They end up worrying needlessly about the natural fluctuations of the market. Investors must slay the ghost of markets past. But many allow the events of 2000-2002 to make them so fearful that they don’t get to enjoy the benefits of investing in equities. Even small downturns in the market cause them to lose sleep. They only focus on the negative and convince themselves the sky is falling. Yet when the markets trend up, they want to grab all of the gains. The markets were down significantly most of 2004 but ended the year up 9%. Those who left the market in fear didn’t have the confidence to get back in early enough to participate in the gains. Investors that want to have all of the gains without going through any losses are going to be very disappointed. It’s like installing a swimming pool. You know it’s a major investment and you plan to use it for years to come. What if every time there was a cold snap or a rainy day, you had a bulldozer come and fill in the pool? “We can’t use it now. We’ve made a big mistake!” Then later, when the sun shines again and warm weather returns, you say, “I need my pool back! Let’s put one in again!” Obviously, you wouldn’t do such a thing. Weather changes are expected and planned for. You shut the pool down in the winter and blow the lines so the pipes don’t burst. You have a solar cover to hold in the heat during swimming season and chemicals to keep the water clean and clear. You don’t fill in the pool with dirt every time something goes wrong. You recognize it is a long-term investment and you use tools to manage the short-term events. It should be the same with your investments. Equities are important to a well-balanced portfolio. Don’t abandon your long-term strategy just because the market has declined several percent. Make tactical decisions based on short-term events within the context of your overall strategy. For instance, I utilize a proprietary portfolio management system that naturally reduces exposure during declines and increases it during upward trends. That allows my clients to pursue the long-term use of equities without losing sleep every time the market drops. Got questions? Go to www.guardingyourwealth.com and click on ‘Ask Jeff’. I’ll answer you personally. In addition to being a nationally syndicated columnist and Certified Financial Planning Practitioner, Mr. Voudrie provides personal, private money management services to clients nationwide.

Fear Of Taxes Can Harm Seniors

When it comes to investing, avoiding taxes should not be your primary concern. Regardless of how much that financial salesperson talks about the importance of deferring taxes, you need to stop and consider these important facts before you make a decision. Otherwise, you can actually lose money instead of saving it. As I talk with seniors from across the nation, it’s obvious they loathe paying taxes. Financial salespeople often play on this dislike of paying taxes to motivate seniors into buying a high-commission investment even though it will earn the senior less in the long run. The only one earning more in this situation is the salesperson! There are two basic kinds of tax-advantaged investments—tax-free and tax-deferred. The two are often confused even though they are very different. For instance, municipal bonds are tax-free. You don’t have to pay any Federal income tax on the interest that you earn on a municipal bond—ever. This allows municipalities to borrow money for public works projects at lower interest rates, saving the public money. The simple way to calculate whether you are better buying a tax-free municipal bond versus a taxable bond is to divide the tax-free yield by 1 minus your tax rate. For instance, if you are in the 28% tax bracket and a 10-year municipal bond is yielding 3.78% then you divide 3.78 by .72, which equals 5.25%. That means that you would have to earn over 5.25% on a taxable bond to give you more after tax income then the municipal bond. Tax-deferred investments work quite differently. Annuities are the most often used tax-deferred investment. You don’t avoid paying income tax in a tax-deferred investment. You only delay paying taxes, which are due when money is taken out of the tax-deferred vehicle. If you don’t plan on using the money yourself, the taxes will still have to be paid at your death. Not only will you have to pay taxes on tax-deferred investments in the future, it is likely that you will have to pay more in taxes then compared to paying the tax now for two reasons. First, any earnings on a tax-deferred vehicle will be taxed at ordinary income rates—for instance the 28% we assumed earlier. If you invested that money in an investment that paid dividends and/or capital gains and paid the taxes now, you would only have to pay taxes at the 10% or 15% level. That’s a huge difference. In our example, earnings taken out of an annuity will be taxed at 28%. Dividends and capital gains off of a mutual fund will be taxed at 15%. That’s a 13% difference! Financial salespeople will use the fear of paying taxes in an attempt to convince a 70 or 80 year old that they should buy an annuity. That is completely bogus! Studies have shown that your money must be left in an annuity for 20-30 years before you begin to see the benefits of tax-deferral. Again, the only one benefiting from the transaction is the salesperson. Don’t fall for this trap. Another trick that financial salespeople will use to sell an annuity is to say that it will keep your Social Security from being taxed. That’s true, but if you use an annuity you’ll push all those taxes down the road. Later on, that could force you (or your heirs if you’re deceased) into a higher tax bracket and you’d end up paying more. Here’s the bottom line. If you’re in a tax bracket of 27% or higher then use tax-free municipal bonds for the income portion of your portfolio. For the equity portion of your portfolio, use tax-efficient vehicles like Exchange-Traded Funds where you can control the timing of the tax event while having the dividends and capital gains taxed at much lower rates. As you can see, there isn’t a single case in my opinion where an older investor will benefit from a tax-deferred annuity. With current tax rates it just doesn’t make dollars and sense. Be smart, do the simple math, and you’ll come out ahead. Got questions? Go to www.guardingyourwealth.com and click on ‘Ask Jeff’. I’ll be glad to personally give you an unbiased opinion. Visit our web site to read previously submitted questions and answers. In addition to being a nationally syndicated columnist and Certified Financial Planning Practitioner, Mr. Voudrie serves clients nationwide using a proprietary money management system he's personally developed.

Beyond the Living Will

Living wills have received a great deal of attention due to the recent Terry Schiavo situation. Because her end-of-life wishes were in dispute, family members battled each other in the courts over her treatment and care. By having a proper Living Will, you can avoid such confusion. But a Living Will doesn’t ensure you have all your bases covered. There are other equally important documents you must have in place. A Living Will deals with end-of-life issues. But what if you’re incapacitated—unable to make your own medical decisions-- for a short time? Who makes medical decisions for you then? What if you’re widowed, divorced or unmarried and you don’t have a spouse who can legally make medical decisions when you can’t? A health care power of attorney allows you to state whom you choose to make medical decisions on your behalf should you not be able to make them yourself. You can also list alternates, should your first choice be unable or unwilling to serve. A health care power of attorney is especially important for those who have lost a spouse and have several living children. Often if Mom or Dad become seriously ill, it’s the out-of-town child that pushes to do everything they can to extend their parent’s life. The last time they saw Mom, she was busy fixing Thanksgiving dinner. Now that she’s in a coma, they have trouble grasping the concept that Mom will never be the same again. And if Mom doesn’t wish to be hooked up to machines for weeks on end, her out-of-town child might not understand. You can just imagine the kind of arguments that can arise when children don’t agree on the proper care of their parent. You can eliminate that situation by designating one child to be your attorney-in-fact. Clearly state in writing through your Living Will and your health care power of attorney, what your specific wishes are. Communicate those to your children, especially your chosen representative. Then if the time comes, you’ve greatly eliminated any possible confusion and ambiguity. A health care power of attorney is activated by your incompetence. Incompetence is often determined based on the opinion of two doctors. With the new HIPPA regulations, this can be a problem. For instance, your doctors may not be willing to offer that opinion citing HIPPA restrictions (HIPPAA does not restrict release of information in those situations). So make sure your health care power of attorney includes language authorizing the release of that information. With all the focus on health care and medical issues, many people forget the practical financial issues that can arise when someone is incapacitated. I’ve seen first hand situations where one spouse develops dementia but still has assets in his or her name. The other spouse is helpless to manage those assets or use them to help cover their loved ones’ care. In these cases, the courts have to determine guardianship, which is not only expensive, but emotionally draining for the family. All this can be avoided with a Durable Power of Attorney for assets. In this document, you choose a representative to make financial decisions on your behalf. You determine when you would like their authority to begin. This makes it much easier to pay your bills, file your taxes, manage your retirement accounts, etc. And again you can list alternates in case something keeps your first choice from serving. If you have minor children, there’s one more document you really must have. The Appointment of Guardian states your choice for who will raise your children in the event of your death. The court still has to make guardianship official, but this document will clearly express your wishes. This document can help your kids avoid being caught in a legal tug-of-war. As the Terry Schiavo case shows us, these documents aren’t just for the elderly. Having them in place will not only make it easier on your loved ones should the unfortunate happen to you, but they will also help ensure that you are properly cared for according to your wishes. Got questions? Feel free to ask me at www.guardingyourwealth.com. I’m in the enviable position of not having to garner new clients and I’d be glad to give you my unbiased opinion. Visit our web site to read previously submitted questions and answers. In addition to being a nationally syndicated columnist and Certified Financial Planning Practitioner, Mr. Voudrie serves clients nationwide using a proprietary money management system he's personally developed.