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I broke my own rule today
Old 04-12-2007, 04:54 PM   #1
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I broke my own rule today

I typically will not give people direct financial advice. But I could not help myself in this case. A friend was being pitched a variable annuity by an agent. He was being told to invest his IRA in a VA. The hook that was convincing him was a step-up feature on the Death Benefit. Every 3 years (on the contract anniversary) the death benefit steps up to the current level of the account (instead of the original amount invested). I think he misunderstood the step up and thought the account level was guaranteed... Of course it would be guaranteed if he died.

Anyway, I recommended to not do it. I will not elaborate on all of the reason's why it was a bad idea. I think most of you already know.

What would you do if you encountered a friend in this situation?
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Re: I broke my own rule today
Old 04-12-2007, 05:07 PM   #2
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Re: I broke my own rule today

If you don't want to give direct advice, why not point them to "advice" somewhere that basically outlines your reasoning? That way it lets them feel like they made the decision using their own reasoning instead of just "because I said so"?

Or, tell them to post on the forum, then they'll get a whole host of advice (wanted or not!)
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Re: I broke my own rule today
Old 04-12-2007, 05:21 PM   #3
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Re: I broke my own rule today

From his interest in this VA you know that his fear is that he will lose principle, but he would also like the upside of equities.To respect that, don't just take away his candy, give him something which speaks to his need but is not abusive-

http://www.investmentu.com/resources...vestments.html

Symbols:

MLF
EUM
MUK

Then charge him a $10,000 fee, and send it on to me. Oh wait, you can keep half for your part.

Ha
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Re: I broke my own rule today
Old 04-12-2007, 05:26 PM   #4
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Re: I broke my own rule today

Mikey,

What would guess would be the SWR of an investment like this?
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Re: I broke my own rule today
Old 04-12-2007, 05:28 PM   #5
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Re: I broke my own rule today

Quote:
Originally Posted by HaHa
Then charge him a $10,000 fee, and send it on to me. Oh wait, you can keep half for your part.
You just gave me a great idea. I'm doing some tax planning, and I want to generate about $10,000 in Schedule C income this year (allows me to write off my medical insurance costs as well as deduct his and hers IRAs).

Let's be investment consultants for each other! I'll pay you $10,000/year if you pay me $10,000/year!
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Re: I broke my own rule today
Old 04-12-2007, 11:07 PM   #6
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Re: I broke my own rule today

I don't agree with your rule....

If I have a friend, i don't want them to make stupid mistakes... I will always give the ADVICE... but not tell them waht to do...

The advice usually give them a few options and the good and bad of those options.... but I will ALWAYS tell them if what they are doing or about to do it a very stupid mistake....

If you don't protect the ones you love, why even exist
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Re: I broke my own rule today
Old 04-12-2007, 11:13 PM   #7
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Re: I broke my own rule today

Quote:
Originally Posted by Cut-Throat
Mikey,

What would guess would be the SWR of an investment like this?
No clue CT. I guess it could be estimated. I have never used them, though I think when the price is right they could be good. Takes a lot of reseach time to keep all these things in the air.

Ha
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Re: I broke my own rule today
Old 04-13-2007, 02:33 AM   #8
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Re: I broke my own rule today

It had a high fee and 8 year surrender charge. It had a larger number of funds than I expected... but many of them I was not familiar with. VG has a similar product offering at half the price. I mentioned that.

One of the main stated benefits of a VA has been the tax shelter. AN IRA is already tax sheltered. VA also have a small insurance component that usuaally guarantees no less than the initial investment to the beneficiary in case of death. The component to this product that appeared to be a real benefit was the step up in Death Benefit. However when asked if he needed\wanted DB... the answer was no. I figured he must have misunderstood what the step up meant.

This seems to be a fairly common ploy today by sales people.... try to get someone with an IRA to move the money into a VA. There is a fair amount of popular press that derides the practice. It is happening enough that the SEC has a page on their site. They do not give advice... but they are clear, there is not additional tax benefit. The benefits the specialty terms that the insurance contract covers.

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Re: I broke my own rule today
Old 04-13-2007, 06:40 AM   #9
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Re: I broke my own rule today

Quote:
Originally Posted by Cut-Throat
Mikey,

What would guess would be the SWR of an investment like this?
CT, if you choose the right product, these VAs can actually turn out to be pretty useful.

With the right product you get a guaranteed 7% return compounded (over rolling 10 year periods) There have been a couple threads on this topic. Many of the companies are selling these contracts too cheaply.

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Re: I broke my own rule today
Old 04-13-2007, 07:58 AM   #10
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Re: I broke my own rule today

Quote:
Originally Posted by Cut-Throat
What would guess would be the SWR of an investment like this?
There is no SWR per say - it depends upon the return of the underlying index. If the index doesn't appreciate over the life of the MITT, your return is zero. Notice you don't get the dividends on the underlying index, which for the S&P 500 is about 1.75% per year (more if the dividends grow). Basically you are buying the price of the index protected with a matching at-the-money European put.

For example, if you price a 4-year European put on the S&P 500, at today's implied volatilities, it would cost about 7.75% of the current price of the index (a little less than 2% per year). What ML does is buy the S&P 500, use the dividends to purchase the put, and sells a MITT (e.g. MLF).

The "risk" to you as an investor is the opportunity cost of tying up your money at a 0% return for 4 years. The benefit to ML is that they get a lower financing rate than they would get on straight debt.

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Re: I broke my own rule today
Old 04-13-2007, 08:05 AM   #11
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Re: I broke my own rule today

Quote:
Originally Posted by HaHa
From his interest in this VA you know that his fear is that he will lose principle, but he would also like the upside of equities.To respect that, don't just take away his candy, give him something which speaks to his need but is not abusive-

http://www.investmentu.com/resources...vestments.html

Symbols:

MLF
EUM
MUK

Then charge him a $10,000 fee, and send it on to me. Oh wait, you can keep half for your part.

Ha
Sounds like a scam. What's the story on these things HA?
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Re: I broke my own rule today
Old 04-13-2007, 08:31 AM   #12
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Re: I broke my own rule today

Quote:
Originally Posted by FIRE'd@51
There is no SWR per say - it depends upon the return of the underlying index. If the index doesn't appreciate over the life of the MITT, your return is zero. Notice you don't get the dividends on the underlying index, which for the S&P 500 is about 1.75% per year (more if the dividends grow). Basically you are buying the price of the index protected with a matching at-the-money European put.

For example, if you price a 4-year European put on the S&P 500, at today's implied volatilities, it would cost about 7.75% of the current price of the index (a little less than 2% per year). What ML does is buy the S&P 500, use the dividends to purchase the put, and sells a MITT (e.g. MLF).

The "risk" to you as an investor is the opportunity cost of tying up your money at a 0% return for 4 years. The benefit to ML is that they get a lower financing rate than they would get on straight debt.

I think that there would be a SWR! - Imagine a FireCalc run where the worst periods of history were not permitted to drive your portfoilo negative. But yet still have some appreciation in up market years. Since the SWR methodology is a 'worst case' tool, I am guessing that an investment like this could provide a very high SWR!

I am sure one of our investing forum geniuses, could figure out a way to simulate this.
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Re: I broke my own rule today
Old 04-13-2007, 09:09 AM   #13
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Re: I broke my own rule today

Quote:
Originally Posted by Cut-Throat


I am sure one of our investing forum geniuses, could figure out a way to simulate this.
Sorry, I'm not a genius. However a treasury bond and call options on the S&P 500 would do the trick

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Re: I broke my own rule today
Old 04-13-2007, 09:22 AM   #14
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Re: I broke my own rule today

Quote:
Originally Posted by saluki9
Sorry, I'm not a genius. However a treasury bond and call options on the S&P 500 would do the trick
Exactly. This would be the functional equivalent to owning the S&P 500 and a European put. I would use a zero-coupon bond (e.g. a Treasury strip) which matures at the expiration of the call.
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Re: I broke my own rule today
Old 04-13-2007, 09:25 AM   #15
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Re: I broke my own rule today

Quote:

It had a high fee and 8 year surrender charge.

VG has a similar product offering at half the price. I mentioned that.
If that was not enough to convince him ... I am afraid your friend is lost.
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Re: I broke my own rule today
Old 04-13-2007, 09:32 AM   #16
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Re: I broke my own rule today

Quote:
Originally Posted by donheff
Sounds like a scam.
No scam here. This is a structured product. Sounds too good to be true, but most people don't understand the embedded put. You are paying for the principal protection by foregoing the dividends. IOW, the present value of the dividends is the price of the put. Since the put is European, it cannot be exercised until maturity. So if the index declines significantly prior to maturity, the security will sell at a discount to par, and you will have to wait until maturity to get your principal back, hence the opportunity cost I mentioned in my posy above.
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Re: I broke my own rule today
Old 04-13-2007, 10:12 AM   #17
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Re: I broke my own rule today

Quote:
Originally Posted by saluki9
Sorry, I'm not a genius. However a treasury bond and call options on the S&P 500 would do the trick

What SWR would you come up with? - I don't trust myself with the inputs, as I don't understand this product yet.
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Re: I broke my own rule today
Old 04-13-2007, 10:22 AM   #18
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Re: I broke my own rule today

Quote:
Originally Posted by Cut-Throat
I think that there would be a SWR! - Imagine a FireCalc run where the worst periods of history were not permitted to drive your portfoilo negative. But yet still have some appreciation in up market years. Since the SWR methodology is a 'worst case' tool, I am guessing that an investment like this could provide a very high SWR!

I am sure one of our investing forum geniuses, could figure out a way to simulate this.
I see what you are getting at. Since FireCalc can't handle options, I think the easiest way to study this would be by building your own spreadsheet with S&P prices (no dividends) and running 4 or 5 year interval simulations with a period return of MAX [0 , price return of S&P]. Of course, the expected return would be less than that of the S&P alone since you are not getting the dividends. My guess is that the SWR's would be lower, not higher, for this reason - certainly not "very high", since S&P total returns are rarely negative over 4 or 5 year periods. But I see your point - would the benefit of avoiding the very few 4 or 5 year periods in which the S&P price return actually declined offset the give up of the dividends over longer periods of time? I would start by looking at the periods that failed in FIRECalc and see how much this security would have helped.
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Re: I broke my own rule today
Old 04-13-2007, 01:22 PM   #19
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Re: I broke my own rule today

Quote:
Originally Posted by chinaco
It had a high fee and 8 year surrender charge. It had a larger number of funds than I expected... but many of them I was not familiar with. VG has a similar product offering at half the price. I mentioned that.

One of the main stated benefits of a VA has been the tax shelter. AN IRA is already tax sheltered. VA also have a small insurance component that usuaally guarantees no less than the initial investment to the beneficiary in case of death. The component to this product that appeared to be a real benefit was the step up in Death Benefit. However when asked if he needed\wanted DB... the answer was no. I figured he must have misunderstood what the step up meant.

This seems to be a fairly common ploy today by sales people.... try to get someone with an IRA to move the money into a VA. There is a fair amount of popular press that derides the practice. It is happening enough that the SEC has a page on their site. They do not give advice... but they are clear, there is not additional tax benefit. The benefits the specialty terms that the insurance contract covers.
VA's should not be offered with the tax benefit in mind for an IRA. The only place I have seen VA's used in a qualified account is where someone wants a guaranteed withdrawal rate regardless of what the market does. However, a lot of VA's are sold in IRA's without that provision, so there's really no help for the client in the contract............
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