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Slightly off topic - investing large sum
12-15-2009, 09:13 PM
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#1
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Thinks s/he gets paid by the post
Join Date: Mar 2007
Posts: 1,854
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Slightly off topic - investing large sum
A relative has recently sold a property and now has $600k to invest. They are in their early '70s, so they want to be fairly conservative and go with some sort of bond ladder. I fully understand the concept of bond ladders, but my questions are more administrative in nature.
They want the portfolio to spin off cash at least annually, and preserve most of the principal. So far I've advised on a bond ladder with something maturing every year, they spend the earnings and reinvest the principal only.
Now for the questions:
1) Where can they buy individual bonds directly? Vanguard?
2) They are in a low tax bracket (other than this year due to this transaction), so I've so far steered them away from tax free bonds. Any other recommendations?
3) What's the best way to minimize transaction fees?
4) Would you buy several bonds of different debtors to minimize default risk? For example, if they buy $50k tranches x 12 tranches, then they could buy multiple issues within the $50k...is that a good idea?
Thanks,
Dave
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12-15-2009, 09:41 PM
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#2
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Thinks s/he gets paid by the post
Join Date: Oct 2009
Posts: 1,190
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First general comment is that buying bonds direct you'd better be prepared to hold to maturity otherwise the transaction costs will eat you alive. Second general comment is that I would not go very far out on the yield curve now (at most three years... at most) given the liklihood of increasing interest rates.
Yes you can buy through Vanguard. That is who I use, but I wonder whether a bond fund (Vanguard and others have them) would be better unless they are comfortable assessing credit risk. The other obvious alternative is bank CDs, which until the "great recession" is clearly in the rear view mirror could be a better riskless alternative. Though obviously CDs will not throw of monthly income.
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12-15-2009, 10:18 PM
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#3
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Thinks s/he gets paid by the post
Join Date: Mar 2007
Posts: 1,854
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Quote:
Originally Posted by LARS
First general comment is that buying bonds direct you'd better be prepared to hold to maturity otherwise the transaction costs will eat you alive. Second general comment is that I would not go very far out on the yield curve now (at most three years... at most) given the liklihood of increasing interest rates.
Yes you can buy through Vanguard. That is who I use, but I wonder whether a bond fund (Vanguard and others have them) would be better unless they are comfortable assessing credit risk. The other obvious alternative is bank CDs, which until the "great recession" is clearly in the rear view mirror could be a better riskless alternative. Though obviously CDs will not throw of monthly income.
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Thanks LARS. My concern about a bond fund is that they need income annually, and would have to sell at market prices, which may be volatile, thus that seems against their risk tolerance. I think buying individual bonds is better, and I agree not go too far out due to the historically low rates just now. CDs may be a short term option too.
I told him to get it in an online savings account that's FDIC insured immediately, as even at 1.5% they're losing $23 a day!!!
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12-15-2009, 10:30 PM
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#4
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Give me a museum and I'll fill it. (Picasso) Give me a forum ...
Join Date: Oct 2006
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Vanguard offers many excellent low cost financial services, buying bonds and having a good bond trading desk isn't one of them.
I have good experience with Schwab and know Brewer uses them also, their commissions a $1/bond $10 min are the lowest among the big discount brokers. I have found the folks at the bond desk to be knowledgeable and helpful.
As far as the size of the transaction the markup (i.e. bid and ask) generally decrease at 10,25,100K level. So while I am not familiar details of how many bonds you need to be diversified my gut says that 12-24 bonds at the 25-50K each laddered over 10 years and not concentrated in any industry should be fine, especially if you stick to A-AA bonds which are currently yielding between 4-6%
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12-16-2009, 06:27 AM
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#5
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Give me a museum and I'll fill it. (Picasso) Give me a forum ...
Join Date: Mar 2003
Posts: 18,085
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Hmmm... So this person wants nothing but bonds? What if we enter an inflationary spiral?
I would strongly suggest something a little different. Something like 40% TIPS, 40% fixed rate bonds and the remaining 20% made up of commodities with maybe a bit of equities or something like MERFX.
However, if they are hell bent on bonds only, I would be reluctant to go with individual corporates unless they are comfortable evaluating credit risk. A much better choice would be CDs (check out Pen Fed and the other usual suspects), TIPS, and a high grade bond fund of no more than intermediate duration. Contrary to what has been stated in this thread, bond funds do throw off interest in the form of monthly, quarterly, or annual distributions. A fund will typically hold hundreds of issues, while an individual would be lucky to diversify across 20 names. If you are just looking to clip coupons, diversification is your friend in the bond world.
I have been happy with Schwab for bonds. The only thing I could fault them for is that the process of selling bonds is cumbersome, but that is more due to the bond market than their setup.
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12-16-2009, 06:38 AM
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#6
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Give me a museum and I'll fill it. (Picasso) Give me a forum ...
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Posts: 10,252
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Another possibility is to buy bonds directly from the US government. TreasuryDirect
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12-16-2009, 08:30 AM
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#7
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Recycles dryer sheets
Join Date: Jan 2008
Posts: 277
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Why not something simple under the Vanguard umbrella? It is very easy to transfer funds from a vanguard account to a bank account using their web page (or between any funds for that matter). A good one-fund choice might be one of the retirement portfolios like retirement income or retirement 2010. Wellesley is very good and conservative. You could mix and match total stock, total bond (or other bond fund) and money market to meet their objectives. Very easy to set up and manage.
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12-16-2009, 02:57 PM
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#8
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Give me a museum and I'll fill it. (Picasso) Give me a forum ...
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Posts: 7,733
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A couple of other thoughts. They are looking to preserve principal so while a bond fund has many advantages preserving principal if interest rates rise isn't one of them.
I am assuming that have other assets and they are simply replacing real estate with fixed income.
A 5 year CD from Pen Fed is 3.0% 5 YR TBill is 2.37
A 5 year bond from a financial firm like BofA, Prudential or Citgrioup is 4-4.8%
Now clearly there is risk in loaning money to a financial firm. On a absolute basis 100-180 basis may not seem enough to compensate for the risk. On the other hand on relative basis A-AA corporate bonds are paying 50% more than CDs and almost twice as treasure. On a 600K investment that is an additional $9,000 in income quite a bit to some one in a low tax bracket.
As far as default risk there certainly is some but one of the many problems with the concept of a too big to fail bank, is you have to ask yourself. If BofA is in such bad shape that it is unable to pay bondholder how likely is their going to be enough money in the FDIC to pay off CD holders?
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12-16-2009, 03:25 PM
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#9
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Thinks s/he gets paid by the post
Join Date: Oct 2009
Posts: 1,190
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Quote:
Originally Posted by clifp
If BofA is in such bad shape that it is unable to pay bondholder how likely is their going to be enough money in the FDIC to pay off CD holders?
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There is zero risk the FDIC will not payout if a bank fails. It may get paid in "worthless" dollars because the Government will just "print" them, but it will get paid. There is zero doubt the Treasury and Congress will fund all FDIC obligations... full stop.
The same cannot be said for BofA. It is possible that BofA could default on its debt. I do agree, however, a failure of BofA (or any money center bank) is not likely given the current administration's approach to bailouts, but it is possible.
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12-16-2009, 03:49 PM
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#10
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Give me a museum and I'll fill it. (Picasso) Give me a forum ...
Join Date: May 2005
Posts: 17,203
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I kind of am a second for Brewers post...
A Vanguard bond fund has a monthly distribution. They can have that directed at their bank.
You can not get a good enough diversification of risk (IMO) buying bonds yourself... I know of a older lady who thought she was when her broker got her into GM bonds.... took a big haircut on those.... now, her others are doing OK, but their income does not make up for a big hit on principal (and not the reduction due to higher interest rates... just a loss in principal)...
The pros can move much quicker than you can to market conditions...
ST 2.4%
Inter 4.11
Long 5.7
Junk 7.4
So, you can slice and dice to get the current income they will need.
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12-16-2009, 04:29 PM
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#11
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Thinks s/he gets paid by the post
Join Date: Apr 2007
Posts: 1,305
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Since the big ONE hit us in 2007/8 and now that we have seen some recovery, I have been looking at increasing our fixed income investments (was 60/40).
Without going into the agonizing recriminations and arm chair quarterbacking that has gone on (especially early in 2008), I am considering going 40/60 with some fairly conservative investments so that DW can sleep at night and to leave her in a position that is more calming to her risk tolerence.
Here is what I am considering for the fixed income part, although I feel it is a bit too conservative:
30% TIPs fund (vanguard has a nice one)
20% stable fund (CD like with a slightly higher payout, in my 401k), so do CDs
20% GNMA fund (vanguard again)
20% Total bond fund
10% Pimco Foreign Bond, unhedged (I think US$ will get weaker)
For even more conservative investments, which I think you are looking for I would consider 25% in each:
TIPS Fund
CDs
GNMAs Fund
Total Bond Market Fund
You may want to convince your relative to put 75% in bonds and 25% in Equities (60/40 US/International). Use Total US Stock fund and Total International Stock Fund.
In any case using funds instead of laddering actual bonds will be much easier to manage. You need to reinvest bond ladder investments when they mature.
Everything I have read points to no advantage to having more than 75% in bonds.
Also, if he/she is in relatively good health, then they might need the growth for health care in the future or maybe that corvette
You may want to glance through the Bonds for Dummies book.
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12-16-2009, 04:39 PM
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#12
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Give me a museum and I'll fill it. (Picasso) Give me a forum ...
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Quote:
Originally Posted by LARS
There is zero risk the FDIC will not payout if a bank fails. It may get paid in "worthless" dollars because the Government will just "print" them, but it will get paid. There is zero doubt the Treasury and Congress will fund all FDIC obligations... full stop.
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There is a non-zero risk that US Government will be unable repay its creditors and default on its debt. That isn't just me saying that S&P and Moody are looking into downgrading our debt from AAA status. Historically most countries have defaulted on their debt at some point, the 21st century maybe our time. I am not saying this is likely just pointing out it is possible.
If Uncle Sam isn't in a position to pay off its primary how will it be in position to pay off its guarrantee for other obligations like GNMAs, FDIC, Farm bank loans and host of others? Outside creditors may enforce severe restriction on these debts being paid.
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12-16-2009, 04:49 PM
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#13
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Thinks s/he gets paid by the post
Join Date: Apr 2007
Posts: 1,305
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Quote:
Originally Posted by clifp
There is a non-zero risk that US Government will be unable repay its creditors and default on its debt. That isn't just me saying that S&P and Moody are looking into downgrading our debt from AAA status. Historically most countries have defaulted on their debt at some point, the 21st century maybe our time. I am not saying this is likely just pointing out it is possible.
If Uncle Sam isn't in a position to pay off its primary how will it be in position to pay off its guarrantee for other obligations like GNMAs, FDIC, Farm bank loans and host of others? Outside creditors may enforce severe restriction on these debts being paid.
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If/When the guvmnt can't repay creditors, then we have more problems then worrying about interest rates. One would need the supply of cans, guns, and ammo. Yes this is an extreme picture, but I also think that there is a big difference between a 'non-zero risk' of government default and losing it's AAA status. 'A' bonds and 'BBB' bonds pay their interest as we speak. IMO government and government agency bonds and insured instruments are as 'safe' as you can get today. Diversification is also an important part of ones portfolio approach.
Where else (besides can goods and bullets) would you advise putting your investment dollars today?
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12-16-2009, 05:10 PM
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#14
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Thinks s/he gets paid by the post
Join Date: Oct 2009
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Quote:
Originally Posted by clifp
There is a non-zero risk that US Government will be unable repay its creditors and default on its debt. That isn't just me saying that S&P and Moody are looking into downgrading our debt from AAA status. Historically most countries have defaulted on their debt at some point, the 21st century maybe our time. I am not saying this is likely just pointing out it is possible.
If Uncle Sam isn't in a position to pay off its primary how will it be in position to pay off its guarrantee for other obligations like GNMAs, FDIC, Farm bank loans and host of others? Outside creditors may enforce severe restriction on these debts being paid.
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The US government is at zero risk of default. Unlike many other countries, all of the US's debt is in US dollars. So all it has to do is print more money to retire its debts. The debt will get paid.... it just may be with worthless dollars. Of course, there could be hyper inflation at this point and the $ could be worthless, but there will not be a default.
Could the US decide to do a strategic default of debt held by foreigners? I suppose that is possible in theory, but practically speaking it will never happen.
Now a country that has debt denominated in a currency other than its own could (and have) defaulted.
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12-17-2009, 06:45 AM
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#15
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Full time employment: Posting here.
Join Date: Nov 2009
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If they are in their early 70's, how high is their risk tolerance? Most people in their 70's are very risk-adverse and more worried about losing what they have than gaining massive interest returns. There is a very good fixed index annuity right now that sounds like it would suit them well, but it is being discontinued as of December 31st. It guarantees the principal in full and allows for free withdrawals up to 86% of the account value after one year with no penalty and has no cap on potential interest earnings (unlike every other fixed index annuity). Both 7 and 10 year products are available. Obviously there are no guarantees on returns, but it is likely they would earn more than the 2-3% interest that fixed products are offering right now.
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12-17-2009, 06:53 AM
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#16
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Give me a museum and I'll fill it. (Picasso) Give me a forum ...
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Quote:
Originally Posted by dgoldenz
There is a very good fixed index annuity right now that sounds like it would suit them well, but it is being discontinued as of December 31st. It guarantees the principal in full and allows for free withdrawals up to 86% of the account value after one year with no penalty and has no cap on potential interest earnings (unlike every other fixed index annuity). Both 7 and 10 year products are available. Obviously there are no guarantees on returns, but it is likely they would earn more than the 2-3% interest that fixed products are offering right now.
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Ah yes, an equity-indexed annuity, just he ticket for a risk-averse couple in their 70's...
From Consumer Reports Money & Shopping:
Quote:
But there are several reasons why we are not big fans of these products. Because there are several different methods of calculating interest, it’s very hard to compare products. The commissions on most of these annuities are high, so the insurance company that sponsors them pass on those costs to investors in the form of high fees. And since they’re classified as an insurance product, they are subject to fewer regulations than securities and may be sold by people who are not registered brokers.
However, that will change, but not soon. Last Friday the SEC posted a new ruleon its Web site that would classify most indexed annuities as securities. Unfortunately, the rule will not take effect until Jan. 12, 2011.
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12-17-2009, 07:19 AM
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#17
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Full time employment: Posting here.
Join Date: Nov 2009
Location: VA
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Quote:
Originally Posted by REWahoo
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There are no fees paid by the investor, 100% of the principal goes into the annuity. There are no annual administrative or wrap account fees either. You are giving up some of the potential earnings in exchange for the knowledge that you will not lose your principal. It's not hard to compare products.....almost every company will give you a projection of how the annuity in its current form would have performed over the worst 10 year period, the best 10 year period, and the past 10 years. If you want something so simple a child could understand it, you can choose a crediting method that compares the value on the first day of the annuity to the value one year from then and credits the interest up to the cap. If it's negative, you get a 0% return. Don't know what's so tough to understand about that. All of the interest calculations are also broken down in the brochure and required to be signed off on by the person purchasing the annuity. The key with index annuities is to find the things you like (high caps, low surrender charges, guaranteed income riders, ability to cash out with no penalty, etc) and be willing to give up the things you don't care so much about (e.g. high surrender charges if you have absolutely no plans to cash out any time soon, lower caps in exchange for guaranteed income, etc).
As with anything, there are always people out there trying to mislead you to make a buck (or a lot of bucks) who will abuse the process. You could say the same thing about any other type of financial product. It always bothers me when financial planners who hold assets under management complain about commissions being made by other people when they are the ones charging wrap fees for doing nothing. One of my clients was paying over $30k per year in wrap fees while his portfolio went down by 50% last year. How's that for a good deal? His planner gave him hell when he signed up for an index annuity with a part of the money in his portfolio.....complained about the high commissions, but didn't mention anything about the $500k+ he had made in fees over the last 20+ years.
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12-17-2009, 07:42 AM
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#19
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Full time employment: Posting here.
Join Date: Nov 2009
Location: VA
Posts: 923
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Quote:
Originally Posted by REWahoo
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I don't see anything in either of those articles that would make me say "I'm staying away from this." In fact, I'd argue the opposite....the first article states that the index annuities outperformed every other asset class in the past 15 years. Both of the essentially say "trust, but verify" which I completely agree with. Know what you're getting before you rush into something, especially with a large sum of money at stake. I didn't say "your parents should put the whole $600k into an index annuity"....but may they can put $100k in there, or $200k, whatever they are comfortable with. Or they can just plod along with 2% returns and paying taxes on them every year. The annuity I referenced does not have ANY surrender charges as long as 4% of the original principal plus 10% is left in the account. You could drop in $1 million and take out $860k the next year with no penalty. Every single other annuity has surrender charges if you take out more than the 10% free withdrawal. That is why I say it is possibly a good fit if they are looking for liquidity, safety, tax deferral, and the potential for better returns. Unfortunately, the product is begin discontinued as of December 31 this year. This is also from one of the most financially sound companies around, not an A- rated company with financial troubles.
By the way, if you read the comments from all of the articles you posted, many of them are from people who bought EIA's and are more than happy with their performance and the fact that they didn't lose a dime last year (or any other year).
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12-17-2009, 07:55 AM
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#20
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Give me a museum and I'll fill it. (Picasso) Give me a forum ...
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Quote:
Originally Posted by dgoldenz
I don't see anything in either of those articles that would make me say "I'm staying away from this." In fact, I'd argue the opposite....
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Out of curiosity, what is the commission payout you would get if you sold a 72 year old couple a $100K EIA?
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