It's nice that we can find common ground on at least one point.
I thought you might like that
Annuities as an Investment
- Thread starter RockOn
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I thought you might like that
FIRE'd@51
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Despite all the hostility shown toward SPIA's on this forum, it is interesting to note that a large portion of folks here (including 2B) claim they are delaying SS until age 70 (or even repaying previously collected SS payments), which, of course, is an annuity paid for by forgoing 8 years of SS payments. Of course, the SS annuity is cheaper (higher withdrawal rate) than buying one from Vanguard and is guaranteed by the US government rather than AIG. So I would conclude that the objection to commercially sold SPIA's is the cost and safety, not the basic principle.
I thought I could put a response in a couple paragraphs. I was wrong. Sorry for the length. I probably mis-read you questions somewhere.
When I said "what people get on average" I meant the "expected value" as defined by Wiki:
Note that this is exactly what Ha suggested, and the calculation method I outlined.
Here's an example. You and I agree to buy a $3,000 CD. I put in $1,000 and you put in $2,000. We let the CD interest accrue inside the CD. Say it grows to $4,000. At maturity we flip a fair coin, the winner gets the entire proceeds. The expected value of the payoff is the same for both of us - $2,000. But notice that neither one of us can actually recieve $2,000. One of use will get $0 and the other will get $4,000.
If I ask the question "What is the game worth to me?", I'll discount the final payoff to today so I can fairly compare it to my cost. The present value of the expected value of the payoff is again the same for both of us, and is $1,500 if we discount at the CD interest rate. So the game is worth $500 to me, and -$500 to you. If we played it many times, that would be our average gains and losses, even though no single round can give either of us $500.
In words that you've used, if I wanted to get the expected value of this game ($2,000 at maturity) on my own, I would need to buy a CD for $1,500 - which is $500 more than I'm putting into the game. So the game looks like a good deal to me. Similarly, it's a bad deal for you.
I understand the bottom line of that to mean that the expected return has risk and is a better deal for some than for others. I think I knew that.
Again, it depends on the question. In the CD example above, the maximum payoff is $4,000 at maturity. That's an important number if you're trying to decide whether to play the game, but it's not the only number you should look at.
In an insurance policy, a couple important questions are "What's the most I could get out if this, if the really bad thing happens? And, how much will I get out of this if a kind of bad happens?" I think that's what you're doing with your live-to-86 example, calculating how the thing looks if a "kind of bad thing" (strictly in the financial sense
I agree, I would either buy life insurance to hedge against the bad or maybe buy a 30 year guaranteed plan to handle the "what if the bad happens" question. Anything wrong with that?
Regarding bonds, let's suppose that you have a history of investing in Treasuries. But today, you're looking at a "B" rated bond. The Treasury has a 100% chance of paying each coupon and the principal on time. The B bond doesn't. It's coupon rate is higher, so if it pays off it's better than the Treasury. You can do the calculation and it might show that $900 invested in the B bond, if it pays in full, will provide as much cash as $1,000 invested in the Treasury. That's a good place to start your analysis. You now know your maximum upside. But, you also want to know the downside. Well, the issuer could go belly-up tomorrow, so the worst case is -$900. But, that's very unlikely.
Your gut tells you that there is some number between -$900 and +$100 which is some sort of average. To do that calculation, lay out a string of probabilities for the B bond paying each of it's coupons, and the maturity payment. (The probabilities are typically a decreasing string of numbers, since the issuer is probably in okay shape today, but your concern is that it will deteriorate over time.) You multiply the probabilities by the corresponding cash flows, discount to today at the Treasury rate, and that gives you a number that is somewhere between the best and worst case. If that number is less than the purchase price of the bond, then I would say you should expect to "get less than you put in (adjusted for the time value of money, which is the Treasury rate)"
In the annuity case, you do the same calculation, but the probabilities are based on a mortality table instead of the possibility of the insurer going under (because you've specified that risk is small enough to ignore). The discount rate may not be Treasuries, because you feel that you're a good enough investor to get something a little better than that. Assuming that you can get the same rate that the insurance company does, then you are using the same method that they use to price the annuity and you're using the same discount rate. If you happen to pick the same mortality table, then you will find that you're "expected loss" is exactly the present value of their expenses and profit.
So SamClem says that this method will always show a loss to you, unless you know something about your mortality that they don't (or they can get better investments than you can).
I think I understand, there are always risks. I could pick a bad company or die early. As far as the SamClem comment, I agree that I am giving up profit and expenses to the insurance company but they are providing a no volatility return and a 6% (or whatever) floor. If I am willing to accept that, that doesn't mean it "will always show as a loss" to me.
Think about this, no matter what the investment is there are costs, how much do brokers get when there is a MA deal? How much do brokers get in a new bond sale? What about stock options to employees diluting my shares? It goes on and on in the Finance Business. Why are insurance companies thought of as different?
That doesn't mean you should never buy insurance. It just means that you should understand that when you add up all the policyowners of an insurance company, their total dollars back will be less than their premiums (adjusted for the interest they could have earned). You don't buy insurance because you expect to beat the insurer at it's own game. You buy because you're trying to reduce the uncertainty in your financial life, which has a value that is measured in "utility" not "dollars"
I agree it has utility value. It is not necessarily the best deal.
thanks for the response
On your cost concern, please see my comments to Independent concerning other investment vehicles. I'd like to know why insurance companies making a profit (even if it is pretty high) is so distasteful. Look at a ordinary Mutual Fund... say it has a 1% annual total cost, if I make 10% (gross) on average they are taking 10% of all of my gains for life. That is not expensive?
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Sarah in SC
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Moderator helpful tip of the day:
Be sure if you are going to quote other posters, that you add any of your own comments under the quoted material (meaning separate and outside of the quoted box) and not just bolding them as part of the quoted material. This prevents other posters from having "words in their mouths" that aren't theirs.
Now back to your regularly scheduled annuity debate...
Be sure if you are going to quote other posters, that you add any of your own comments under the quoted material (meaning separate and outside of the quoted box) and not just bolding them as part of the quoted material. This prevents other posters from having "words in their mouths" that aren't theirs.
Now back to your regularly scheduled annuity debate...
FIRE'd@51
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No objection - I was just pointing out that those who want an annuity can get a cheaper and safer one by delaying (repaying) SS. Of course, this will be limited to the maximum SS one can get, so, if you want 100K a year you will need to purchase most of it from a commercial entity.
Sarah, I'm sorry about that, I haven't figured out how to break up the quote like you suggest. Putting my comments inside the quote in bold seemed easier than a few other choices I had. I will not do that again. I wouldn't want to put my words in Independents mouth, that's for sure.
HFWR
Give me a museum and I'll fill it. (Picasso) Give me a forum ...
Use quote in brackets at the beginning, and /quote in brackets at the end.
Your text...
Your text...
Your text...
Your text...
I'll likely be doing the repaying SS option also, if it is still available. I haven't run the IRR of investing money into that plan but I suspect it's pretty high. An idea for another thread!
HFWR
Give me a museum and I'll fill it. (Picasso) Give me a forum ...
Thanks
Yes, each quote must start with [ quote] and end with [ /quote], without the space I put in to keep from quoting myself...
Notmuchlonger
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I really want to learn more about annuities.
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I really want to learn more about annuities.
Here we go again, is this really that much fun for you?
Notmuchlonger
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Oh I think you are having a great time aren't you
Why all of us here want to know about annuities. Go ahead Im sitting and learning Why are you so hostile to people who want to learn about annuities?
I have read in the past that Whole Life policies only have an IRR of 2% or so. Term Life is now known to be a much better deal for most. For me, what makes SPIA's somewhat atractive is the higher IRR's within the product and finding that out was actually a big surprise for me. I expected to find the 2% to 3% again. I wonder if some of the negativity on SPIA's is a hangover from the public learning about the horrible IRR on Whole Life.
Oh I think you are having a great time aren't you
Why are you so hostile to people who want to learn about annuities?
Great post, such love.
Notmuchlonger
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I agree with you 100%. So then you have found your answer to the great annuity question. See me and you are on the same page 100% fight the good fight!
You do! God, I give up! On to the IRR of the repaying SS plan! We'll both be rich soon!
I missed that one. I take exception the the SPIA related statement. Don't you follow the the CPI threads?
Actually I've commented on many things.
I'll be moving on to a few new ideas soon. I bet you can't wait.
Rich_by_the_Bay
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I'll be moving on to a few new ideas soon. I bet you can't wait.
RockOn, you comments are taking on a baiting and sarcastic quality. This is against community rules pertaining to trolling.Great post, such love.
In fairness, I also urge the responders to not rise to the bait; either reply to the points or move on. If you have complaints, report them to the mods using the little triangle icon at the lower left.
We are trying to be fair to all sides, but frankly, this thread is circling the drain.
Independent
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RockOn, your comments are in bold. I didnt' copy my whole post.
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I understand the bottom line of that to mean that the expected return has risk and is a better deal for some than for others. I think I knew that.
I think you're saying that if you look at annuity buyers, some will end up with a better result than others. That is a true statement, but it's not my point.
I was trying to say that if you add up the results of all the annuity buyers of one company, their total result will always be less than they could have gotten by pooling their money and buying the same mix of assets that the insurance company buys. (Since insurers buy bonds, and you can get similar bonds through many mutual funds, you can realistically get something close to what an insurance company can get.)
It's as if you are saying that if a thousand people all play roulette in Las Vegas, they will all get different results. However, I am saying we also know that as a group they will walk away from the tables with less money than they brought in, because the odds are set so the house can cover its expenses and make a profit. When you buy insurance, the company is the house.
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In an insurance policy, a couple important questions are "What's the most I could get out if this, if the really bad thing happens? And, how much will I get out of this if a kind of bad happens?" I think that's what you're doing with your live-to-86 example, calculating how the thing looks if a "kind of bad thing" (strictly in the financial sense
) happens. I think that's a good question to ask and answer. But it's not the whole picture on a close decision. I agree, I would either buy life insurance to hedge against the bad or maybe buy a 30 year guaranteed plan to handle the "what if the bad happens" question. Anything wrong with that?
I think we've got different definitions of "bad" here. For life insurance, bad event that will cause the big insurance payoff is dying too soon. For an annuity, the "bad" event that will cause the big payoff is living too long.
I'm simply saying that when you consider buying an annuity, it's logical to look at the payoff in cases where you live past your life expectancy. You are doing that. It's also wise to look at other cases where you die early. You can end up with a lot of cases - Ha's method was a systematic way to average all the cases together.
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I think I understand, there are always risks. I could pick a bad company or die early. As far as the SamClem comment, I agree that I am giving up profit and expenses to the insurance company but they are providing a no volatility return and a 6% (or whatever) floor. If I am willing to accept that, that doesn't mean it "will always show as a loss" to me.
I hope this is getting to be semantics. I'll state this principle: The "expected value" of the payoff on an annuity (SPIA) is less than the premium, if you calculate expected value using the interest rate and the mortality table the insurer uses in pricing. If that makes sense to you, then there's no point in worrying about other words that can describe that fact.
I'm at a loss for the "6% floor". I'm sure that you know that you can get much less than 0% if you die too soon.
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Think about this, no matter what the investment is there are costs, how much do brokers get when there is a MA deal? How much do brokers get in a new bond sale? What about stock options to employees diluting my shares? It goes on and on in the Finance Business. Why are insurance companies thought of as different?
I think the issue here is that a "pure investment" will outperform an insurance product "on average". (That's the "principle" above.) The reason is that insurers assume extra risks that pure investment intermediaries don't assume. This means they commit more capital and have bigger expenses. You can get a feeling for how much you're paying to have them assume these risks by doing Ha's calculation.
The title of the thread, and some of your comments, seem to suggest that you think there is no extra cost.
I'm not saying that it's irrational to pay an insurance company to assume risks for you (I have a number of insurance policies and I think that I'm rational). I am saying that it's worthwhile to remember that you are paying a fee to have them assume those risks. In the case of an SPIA, it is NOT true that you are getting the full investment return you might get on a pure investment vehicle while having them take the risks as a freebie.
Rich,
Sorry it was only because of who jumped into the Thread with the "I really want to learn more about annuities" comment. Most obviously that was not a sincere statement.
I thought my responses were appropriate responses to that. I thought in fun.
It won't happen again but I think it should be a two way street.
Maybe I wasn't clear on one thing, thewas intended toward me. I thought 2B would enjoy that if he happens to catch it.
Sorry it was only because of who jumped into the Thread with the "I really want to learn more about annuities" comment. Most obviously that was not a sincere statement.
I thought my responses were appropriate responses to that. I thought in fun.
It won't happen again but I think it should be a two way street.
Maybe I wasn't clear on one thing, the
was intended toward me. I thought 2B would enjoy that if he happens to catch it.
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All good comments as always. The only comment I have is when I said floor I mean the IRR is guaranteed to be there if I live as long as I think I will.
If it's a satisfactory minimum rate, it's a pretty good deal to be able to lock it in for life.
I can't think of another investment that does that.
I definitely do not think annuities are a freebie in any way. I would pay a good price for the non-volatile return just like you might pay a good price for a Mutual Fund if you add up all the fees throughout the years. I am not saying the ultimate annuity expense is less or more than the mutual fund, it really depends on what the markets do in regard to Mutual Fund returns.
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Sarah in SC
Moderator Emeritus
And then this image of HFWR singing came into my mind, unbidden:
Excuse me, while I quote myself
(sung to the tune of "Excuse me, while I kiss the sky
with sincere apologies to the late J. Hendrix)
O0
haha
Give me a museum and I'll fill it. (Picasso) Give me a forum ...
This is an unusually lucid explanation of what is for many people a difficult concept. Independent's entire post is excellent; I just didn't quote all of it.
I hope the thread will not be closed, because a) the topic is very important to retirees, even those who don't yet realize that it may be important; and b) people are being quite civil.
FYI, I don't have an annuity even though I think there is a lot to be said for them, because I have a hard time trading possible reward for risk abatement-even when the trade is free which as independent has shown the purchase of an annuity is not. Delaying SS is as close as I will come so far.
Ha
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