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Old 05-16-2008, 08:35 PM   #21
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IRR isnt the best way to measure return from an annuity. Its a mediocre tool that is somewhat acceptable for comparing similar annuities to each other. It is absolutely not a useful tool to measure an annuity vs other types of investments.

And you're still doing it wrong.

For most people living an average lifespan, an annuity will pay back somewhere between 3.5 and 4.5% a year, CPI adjusted, over someone with a 30 year horizon. About the very best you'll manage is something analog to a cd ladder or a long bond ladder, minus a little bit.

If you lowball the inflation adjustment vs the actual observed average rate for the last 25 years (which you have), work in an expectation of living 7-8 years longer than average (which you have), and use an improper methodology to compare two dissimilar investments...you can get a 6% figure that has nothing to do with rates of return from a non annuity product.

By using relatively low volatility investment products I've made an average of 14% a year since the early 90's.

Thats better than 3.5%, 4%, 4.5% or the unlikely 6%.

And just to be clear, I have no issue with different investment products and have a very open mind to good ideas. I'm not thrilled with misinformation. Especially highly repetitive misinformation.
You probably know what I think, with all respect you are not correct. IRR is the correct method to measure investments, especially useful for those with predictable returns. It creates apples to apples comparisons. If you know how to make make 14% a year for 18 years straight, I wouldn't be looking at annuities either, I can understand your dislike. I'm surprised you are not off sailing the Pacific. For those of us satisfied with a ~6% return for a part of our funds (or maybe even all as in my case, though I'd like 7%), annuities do accomplish that if you live about 30 years after annuitizing (mid 50's or so) and the insurance compnay stays solvent. Living to 86 is a reasonable life expectancy for planning purposes according to almost every FA I have read. I think you are the one with the highly repetitive misinformation, sorry.

By the way I did not lowball an inflation adjustment, the 6% IRR is there even if you don't take any inflation adjustment. The payments would be much higher to start. I agree I am assuming living 7-8 years longer than the tables, I think that is a reasonable thing to do, I bet you (or at least most of us) use age 86 or so in SWR calcs also. If I didn't assume the living to 86, the IRR doesn't drop to 3.5 or 4%, or 4.5% as you think, it drops to ~5.4%. I don't know about you, but I plan to live to the mid-80's, and am willing to stake my bets on that, we'll see of course.

Maybe? you are saying annuities pay a 3.5 to 4.5% real return, then you are correct. I am saying a 6% nominal return, like the annualized return that Mutual Funds advertise.

Last point, I think the return is similar to a cd ladder or long bond ladder. But without any volatility. Right now it is not possible to get 6% in those ladders, we don't know about the future, 6% has been hard to get consistently for many years. It goes up and down. With the annuity you are getting the 6% for the whole 30 years, nearly enough for my planning.
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Old 05-16-2008, 08:50 PM   #22
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IRR is the correct method to measure investments, especially useful for those with predictable returns. It creates apples to apples comparisons.
No, and no.

Insurance companies sure do talk up the use of IRR because it makes financially naive people think they're going to get a better return vs other investments.

Internal Rate of Return: A Cautionary Tale - Buyer's Guides and Special Reports - Budgeting and Planning Software - CFO.com

"For decades, finance textbooks and academics have warned that typical IRR calculations build in reinvestment assumptions that make bad projects look better and good ones look great."

"Practitioners often interpret internal rate of return as the annual equivalent return on a given investment; this easy analogy is the source of its intuitive appeal. But in fact, IRR is a true indication of a project's annual return on investment only when the project generates no interim cash flows or when those interim cash flows really can be invested at the actual IRR.

When the calculated IRR is higher than the true reinvestment rate for interim cash flows, the measure will overestimate sometimes very significantly the annual equivalent return from the project. The formula assumes that the company has additional projects, with equally attractive prospects, in which to invest the interim cash flows. In this case, the calculation implicitly takes credit for these additional projects. Calculations of net present value (NPV), by contrast, generally assume only that a company can earn its cost of capital on interim cash flows, leaving any future incremental project value with those future projects."


Internal rate of return - Wikipedia, the free encyclopedia

"IRR is an indicator of the efficiency of an investment, as opposed to net present value (NPV), which indicates value or magnitude."

"As an investment decision tool, the calculated IRR should not be used to rate mutually exclusive projects, but only to decide whether a single project is worth investing in"

"IRR makes no assumptions about the reinvestment of the positive cash flow from a project. As a result, IRR should not be used to compare projects of different duration and with a different overall pattern of cash flows. Modified Internal Rate of Return (MIRR) provides a better indication of a project's efficiency in contributing to the firm's discounted cash flow."
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Old 05-16-2008, 08:55 PM   #23
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No, and no.

Insurance companies sure do talk up the use of IRR because it makes financially naive people think they're going to get a better return vs other investments.

Internal Rate of Return: A Cautionary Tale - Buyer's Guides and Special Reports - Budgeting and Planning Software - CFO.com

"For decades, finance textbooks and academics have warned that typical IRR calculations build in reinvestment assumptions that make bad projects look better and good ones look great."

"Practitioners often interpret internal rate of return as the annual equivalent return on a given investment; this easy analogy is the source of its intuitive appeal. But in fact, IRR is a true indication of a project's annual return on investment only when the project generates no interim cash flows — or when those interim cash flows really can be invested at the actual IRR.

When the calculated IRR is higher than the true reinvestment rate for interim cash flows, the measure will overestimate — sometimes very significantly — the annual equivalent return from the project. The formula assumes that the company has additional projects, with equally attractive prospects, in which to invest the interim cash flows. In this case, the calculation implicitly takes credit for these additional projects. Calculations of net present value (NPV), by contrast, generally assume only that a company can earn its cost of capital on interim cash flows, leaving any future incremental project value with those future projects."


Internal rate of return - Wikipedia, the free encyclopedia

"IRR is an indicator of the efficiency of an investment, as opposed to net present value (NPV), which indicates value or magnitude."

"As an investment decision tool, the calculated IRR should not be used to rate mutually exclusive projects, but only to decide whether a single project is worth investing in"

"IRR makes no assumptions about the reinvestment of the positive cash flow from a project. As a result, IRR should not be used to compare projects of different duration and with a different overall pattern of cash flows. Modified Internal Rate of Return (MIRR) provides a better indication of a project's efficiency in contributing to the firm's discounted cash flow."
Very good, I'll think about that, but for now just give it the benefit of the doubt.

Try this, I buy a 6% IRR annuity, you use a 60/40 portfolio. You make a consistent 6% annualized for 30 years. We both withdraw the same $ amount, at the same frequency, for the same number of years. What happens after 30 years and we both die. We are both worth $0. (Note: if I continue to live longer I actually still get my payments, my IRR went up! You are still broke.)

You should quote all of wikipedia:
The IRR is the annualized effective compounded return rate which can be earned on the invested capital, i.e., the yield on the investment.
A project is a good investment proposition if its IRR is greater than the rate of return that could be earned by alternate investments (investing in other projects, buying bonds, even putting the money in a bank account). Thus, the IRR should be compared to any alternate costs of capital including an appropriate risk premium.
Mathematically the IRR is defined as any discount rate that results in a net present value of zero of a series of cash flows.
In general, if the IRR is greater than the project's cost of capital, or hurdle rate, the project will add value for the company.

Your first link deals with "interim cash flows", I don't think it is valid in this case. I suppose it could apply in stock investing. I don't think it makes much difference in this example. The problems with IRR seem to come up when there are "reinvested" positive and negative flows, with the annuity there are only positive flows with no interim flows and no reinvestments, with the portfolio I am assuming there were only 6% yearly positive flows. I wouldn't know how to go about assuming otherwise, I don't think it would make much difference
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Old 05-16-2008, 09:12 PM   #24
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You are under the persistent mistaken impression that a person who invests 25x their annual budget with a 60/40 portfolio runs out of money after 30 years.

Once again, this is incorrect and rarely the case. The average person after 30 years has far more money, even counting inflation adjustments, than they started.

In 30 years I'll still be making good money and spending it. You'll have a CPI adjusted annuity thats lost buying power to the tune of 6% a year. After all, you insisted on the latter point so you must agree.

A 60/40 average ROI for 30 years is also a lot more than 6% annualized.

If you were a piece of capital equipment, IRR still wouldnt be the best way to measure your efficiency of investment. As a cash flow tool, its inadequate at best and misleading at worst.

You remind me of another guy that used to come around now and then who thought if a Quicken calculator spit something out, it was gospel. No nevermind about the quality of the inputs, the validity of the assumptions, or the applicability of the calculator to the problem at hand.
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Old 05-16-2008, 09:24 PM   #25
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RockOn, you are failing to distinguish between annuities (which are appropriate for some investors) and the salesmen that harangue this board on behalf of a high-commission product. They're an extremely vocal crowd of shills and they've given the product a bad name.

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Are you totally convinced you can beat a 6% rate of return by managing your own portfolio in the last 30 years or so of your life? If you are, I understand why you would not like annuities and that's fair.
I've been 12-15% APY for the last five years and I've racked up an overall record of 11% APY since 1982 (that includes money market funds and everything) so I'm happily convinced that I can make at least 6% on the compounded remains for the rest of my life.

And I'm totally convinced that I can beat any returns an insurance company hopes to achieve, since I won't be paying their expenses and subject to their regulatory requirements.

Annuities are appropriate for those who want insurance or total financial management or some form of liability shelter, but they're not appropriate for those who are seeking a market return.
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Old 05-16-2008, 09:45 PM   #26
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You are under the persistent mistaken impression that a person who invests 25x their annual budget with a 60/40 portfolio runs out of money after 30 years.
Ok, but my only point is this. If you did make 6% annualized with your 60/40 and withdrew the same amounts, at the same frequency, for the same number of year, as my 6% IRR annuity, your account would be $0 after 30 years, 100% of the time. That is all.

I'm not saying the annuity is better or even a reasonable choice for many, only that if I lived 30 years after annuitizing, my outcome would be the same as the one described above. It might not be enough of a return for you, it might be good enough for me.

P.S. on your points about miscalculation, I still think my calcs are fine. Maybe someone can clear that up. We don't agree there. My inputs and assumptions seem perfectly fine to me.

Lastly I really don't see why you think an insurance company would not pay an IRR of 6%. An annuity is just a very, very, long term bond, there are 6%, 30 year bonds out there today. A state pension plan that I am aware of currently assumes a ~8.5% annualized investment return, they could easily pay 6% if they had to. Why couldn't insurance companies do the same?
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Old 05-16-2008, 09:52 PM   #27
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RockOn, you are failing to distinguish between annuities (which are appropriate for some investors) and the salesmen that harangue this board on behalf of a high-commission product. They're an extremely vocal crowd of shills and they've given the product a bad name.


I've been 12-15% APY for the last five years and I've racked up an overall record of 11% APY since 1982 (that includes money market funds and everything) so I'm happily convinced that I can make at least 6% on the compounded remains for the rest of my life.

And I'm totally convinced that I can beat any returns an insurance company hopes to achieve, since I won't be paying their expenses and subject to their regulatory requirements.

Annuities are appropriate for those who want insurance or total financial management or some form of liability shelter, but they're not appropriate for those who are seeking a market return.
I agree 100%.

My point is that I do not need a market return, reducing risk of an unsatisfactory outcome is important to me. You will do much better than I with the track record you have shown, I'm not trying to take that from you. But, if I can make a "safe (questionable of course)" 6% IRR, my life is good, my kids are pretty well off after I am gone. Some of us value things differently. I don't see why some think this is wong. Whether annuities get me to the safe 6%, that's the question I want to explore. If nothing else we could look at annuities as a worse case bottom line "safe?" outcome. It is nice to have that, especially if that return is in the 6% range for many of us.

I'll add that I wil not jump in on this anymore, sorry for altering the OP. I have been given a lot of good info and any decisions I make on annuities will be mine to make. I'm comfortable with my calculations, if anyone thinks I'm missing something major, I'd like to hear about it. I'd like to see the general annuity bashing stop since I do not think I am alone in seeing annuities as a viable retirement option. IMO why not just see them for what they are...fairly safe....moderate to low rate of return (similar to fixed income) investments.....with their own issues? Not wonderful, not all trash, just another investment option. Bash the sales tactics, that's fine; bash specific products, that's fine; but not annuities overall as some products are decent investments for conservative people.
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Old 05-16-2008, 10:08 PM   #28
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Ok, but my only point is this. If you did make 6% annualized with your 60/40 and withdrew the same amounts, at the same frequency, for the same number of year, as my 6% IRR annuity, your account would be $0 after 30 years, 100% of the time. That is all.
Except that I wouldnt make a mere 6%, I wouldnt take 6% out of the portfolio because thats unsustainable, and you wouldnt make 6% on your annuity. Unless you lived longer than 95% of the rest of the population and didnt mind the erosion of buying power when you're too old to get a job.

So other than every assumption being incorrect or unlikely, yep...you're good.

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P.S. on your points about miscalculation, I still think my calcs are fine. Maybe someone can clear that up. We don't agree there.
I'm not arguing your calcs. I'm saying your assumptions are wrong, your inputs are wrong, and your preferred algorithm is wrong.

Other than that, again...you're fine.
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Old 05-16-2008, 11:18 PM   #29
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Except that I wouldnt make a mere 6%, I wouldnt take 6% out of the portfolio because thats unsustainable, and you wouldnt make 6% on your annuity. Unless you lived longer than 95% of the rest of the population and didnt mind the erosion of buying power when you're too old to get a job.

So other than every assumption being incorrect or unlikely, yep...you're good.



I'm not arguing your calcs. I'm saying your assumptions are wrong, your inputs are wrong, and your preferred algorithm is wrong.

Other than that, again...you're fine.
Ok, whatever.
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Old 05-16-2008, 11:21 PM   #30
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I'm probably a nerd, but the only thing I can think of is a well-worn physics joke.

The punchline is "first, assume a spherical chicken"
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Old 05-16-2008, 11:26 PM   #31
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Ok, whatever.
And I need a double secret probation ignore list that doesnt give me the option of pressing the shiny, pretty red button.

Have you noticed that when expressing your thoughts about various topics, when the discussion rotates back to actual facts and data you become reclusive and respond with helpful posts like "Ok, whatever" ?

You will do what you want to do. Your justifications for feeling the government is loaded with inflation black helicopters offset by your insurance company's efforts to keep you solvent are well taken.

Just dont confuse people along the way.

If you're in your 60's or 70's, are in very good health, are concerned about running out of money in your 90's and are okay with annuity payouts, buy one.

But as an early retiree in your 40's or 50's, dont think you'll make a free lunch forever 6% return by buying one based on the results of a poorly accepted formula for capital equipment projects that doesnt apply one iota to comparisons of annuities vs other investment products.
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Old 05-16-2008, 11:27 PM   #32
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The punchline is "first, assume a spherical chicken"
DING DING DING!

And as an aside, I like your computer.
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Old 05-16-2008, 11:41 PM   #33
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And as an aside, I like your computer.
Thanks. I gotta say, I do too
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Old 05-17-2008, 12:23 AM   #34
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Have you noticed that when expressing your thoughts about various topics, when the discussion rotates back to actual facts and data you become reclusive and respond with helpful posts like "Ok, whatever" ?
Sorry, I cannot have a discussion with someone who is sure they know they are right but offer little in logic, fail to address the points, and are rude. Others can see it for what it is.

If my assumptions don't fit your reality you become closed minded. Sorry, but true.

Ok, let's go with your reality. Most die before the tables say; the 60/40 portfolio will be up 14% a year forever; your portfolio is guaranteed to be inflation protected; annuities have an IRR of 4%; IRR's are only valid for capital equipment purchases and have never been used correctly for comparing investments; nobody would even consider investing for a 6% yeld. Annuities really do suck, what was I thinking!

My way out there assumptions were:
I might live to 86 and choose to base my payouts on that age
My current age is 53
The payouts on Vanguard are real
IRR is a valid way to compare fairly simple investment returns
My calculator works and the 3 people who confirmed my IRR calcs know what they were doing

What else? It's about that simple. But my "inputs, assumptions, and modeling" are just unbelieveable.


One of your bold quotes:
"I'm not arguing your calcs. I'm saying your assumptions are wrong, your inputs are wrong, and your preferred algorithm is wrong."

The only things you could argue are my life expectancy and using IRR. When I gave my view on using 86 as my life expectancy, you didn't comment. On IRR, I could be proven wrong, but you surely didn't prove it. Not accepting a cash flow calculation to determine IRR as a valid way to compare these two pretty simple investments seems pretty far out there to me, haven't heard that one before.
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Old 05-17-2008, 06:44 AM   #35
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Rockon,

If you really want to examine your IRR assumptions, run your financial plan through FIRECalc both with a substantial percentage of your assets annuitized (use Vanguard numbers) and without. I suggest you don't use the "inflation adjusted" annuity numbers because they are full of exception and limitations. When you do the runs you will find (1) the success rate or 95% "safe" withdrawl will be higher in the annuitized portfolio and (2) the non-annuitized portfolio will have many, many runs that overwhelm the asset growth of the annuitized portfolio.

The bottom line is just what you said. Very conservative investors have a higher success rate but have very limited upside. You expose yourself to higher credit risk (unsecured creditor of the insurance company), no or limited inflation protection, illiquidity and undermarket return on your assets.

CFB and Nords are correct in that their portfolios over the long term will perform better than the nominal 6% you find so attractive. They will have more flexibility with their assets for future needs and achieving "expected" rather than "minimum" returns will allow them options unavailable if their assets are annuitized.

I'll come back to a suggestion I made earlier. If you accept the credit risk of an annuity, you are an unsecured creditor of the insurance company. You can spread your money between several companies but you are still not very diversified. Rather than annuitize, buy preferred stocks in a range of companies with "good" credit ratings. In a default they aren't as high as a bond but they will get money long before the unsecured annuity holder does. These high grade preferreds are paying 6 to 8% and can be spread accross dozens of companies. It significantly beats your IRR no matter how you calculate it. It is more secure than an annuity. The real kicker is you still have access to your principle.

Now I consider this suggestion to totally negate any benefit of an annuity unless you are in the sales force.
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Old 05-17-2008, 09:59 AM   #36
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Rockon,

If you really want to examine your IRR assumptions, run your financial plan through FIRECalc both with a substantial percentage of your assets annuitized (use Vanguard numbers) and without. I suggest you don't use the "inflation adjusted" annuity numbers because they are full of exception and limitations. When you do the runs you will find (1) the success rate or 95% "safe" withdrawl will be higher in the annuitized portfolio and (2) the non-annuitized portfolio will have many, many runs that overwhelm the asset growth of the annuitized portfolio.

The bottom line is just what you said. Very conservative investors have a higher success rate but have very limited upside. You expose yourself to higher credit risk (unsecured creditor of the insurance company), no or limited inflation protection, illiquidity and undermarket return on your assets.

CFB and Nords are correct in that their portfolios over the long term will perform better than the nominal 6% you find so attractive. They will have more flexibility with their assets for future needs and achieving "expected" rather than "minimum" returns will allow them options unavailable if their assets are annuitized.

I'll come back to a suggestion I made earlier. If you accept the credit risk of an annuity, you are an unsecured creditor of the insurance company. You can spread your money between several companies but you are still not very diversified. Rather than annuitize, buy preferred stocks in a range of companies with "good" credit ratings. In a default they aren't as high as a bond but they will get money long before the unsecured annuity holder does. These high grade preferreds are paying 6 to 8% and can be spread accross dozens of companies. It significantly beats your IRR no matter how you calculate it. It is more secure than an annuity. The real kicker is you still have access to your principle.

Now I consider this suggestion to totally negate any benefit of an annuity unless you are in the sales force.
I'll go with that. Pretty well put. The 1) point above is my point also. I also agree 100% with 2). I don't necessarily agree with the last sentence.

IMO what the 3 of you are missing is that many people are afraid to invest in your ideal porfolios because of risk. There is a lot of money in cd's and mm funds. For people with that risk tolerance, a 6% rate of return on an annuity might make sense as the return is likely higher than a cd ladder or MM funds. Even if they only put 1/2 of their money in the annuity, with that steady income as a backstop to cover many of their living expenses they might be able to put 1/2 in a riskier portfolio. In that case the annuity can be very valuable. (In my case 1/2 in an annuity would cover the entire 2.5 to 3% SWR I was assuming from my assets, if I put 1/2 in an annuity I could handle lots of risk with the other 1/2. If the risky invested funds did crap out; for whatever reason, look at Japan stock market as an example of how things could go wrong; I'd still be ok.)

On the preferred stock option, I own 2 closed end preferred funds just for your reasoning. Both of them were down 40% from their highs in the last year. (I bought them a few months ago and I should have bought a lot more the way it looks.) However, to me that investment is almost as risky as 100% stocks, and the 60/40 portfolio; down 40% in one year is huge. I like the yields but the volatility is not low.

Any other ideas on how to get a long term 6% return? I am looking for options with "little or no volatility". Annuities are about it as I see it, at least right now. A bond ladder might come close if one was able to buy individual issues and stay away from treasuries. The bond funds yield less and have for quite a few years now. I'm always looking, I was surprised to see that SPIA annuities can provide that type of return with fairly low risk and no volatility. I haven't bought any, but still might in a few years. It is a viable option.

I think the big disagreement here has been whether the ~6% IRR from SPIA's is correct. I believe it is and believe you agree from what you have said. I don't know why we can't just accept that. Arguing whether IRR is a correct way to calculate yield, or is a rigged method to benefit the insurance companies saleforce, seems futile. Just because it is close to 6% for a mid-80's lifespan doesn't mean anyone should buy annuity, that is up to them.

I should add that with the state guarantees and the fact regulators step in during an insurance default, I believe annuities are significantly safer than individual bonds and preferred stocks. Maybe I am wrong there but I think that has been backed up a few times now.
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Old 05-17-2008, 12:39 PM   #37
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Maybe I am wrong.
Finally a little accuracy.
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Be fearful when others are greedy, and greedy when others are fearful. Just another form of "buy low, sell high" for those who have trouble with things. This rule is not universal. Do not buy a 1973 Pinto because everyone else is afraid of it.
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Old 05-17-2008, 02:27 PM   #38
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Any other ideas on how to get a long term 6% return? I am looking for options with "little or no volatility". Annuities are about it as I see it, at least right now. A bond ladder might come close if one was able to buy individual issues and stay away from treasuries. The bond funds yield less and have for quite a few years now. I'm always looking, I was surprised to see that SPIA annuities can provide that type of return with fairly low risk and no volatility. I haven't bought any, but still might in a few years. It is a viable option.
No, as you raise the return you're going to raise the volatility.

Your attempt to eliminate the volatility raises a whole 'nother crop of problems. If you feel that annuities will solve your volatility problem then that's what you should do.

I think we're done here.
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Old 05-17-2008, 02:46 PM   #39
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Its the whole risk / reward thing. Crap I slipped up and got into this thread again
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Old 05-17-2008, 08:44 PM   #40
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If you accept the credit risk of an annuity, you are an unsecured creditor of the insurance company. You can spread your money between several companies but you are still not very diversified. Rather than annuitize, buy preferred stocks in a range of companies with "good" credit ratings. In a default they aren't as high as a bond but they will get money long before the unsecured annuity holder does.
If I may interject, this is not really true. In a bankruptcy, preferred stockholders are lower in priority than all creditors -- secured or unsecured. Preferreds rank ahead of common stockholders, but that is all.
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