360° Coverage : Calibrate Your Investment Risk

2 Updates

Calibrate Your Investment Risk

Apr 4 2014, 4:17pm CDT | by

Upside with downside protection. Especially after the unfortunate adventures of 2008-2009 isn’t that what everybody wants? A product touting those features should sell like hotcakes, so naturally...

Filed under: news


23 weeks ago

Calibrate Your Investment Risk

Apr 4 2014, 4:17pm CDT | by

Upside with downside protection. Especially after the unfortunate adventures of 2008-2009 isn’t that what everybody wants? A product touting those features should sell like hotcakes, so naturally Wall Street is just too happy to supply it – Even if the product isn’t very good, it will sell. Which brings us to the equity linked annuity, a product so poorly understood and toxic that even FINRA noticed.

Most investors dislike loss. And we know that they dislike it more than twice as much as they enjoy gain. Unfortunately, given this risk aversion bias some investors make poor choices. Wall Street has mastered the art of guiding investors to make sub optimal decisions.

As background remember the basic risk-reward line that starts at the zero risk asset and passes through some version of the global equity portfolio. The line thus formed should be considered the natural limit of expected returns at any particular risk level. It’s delusional to think that your portfolio is going to generate returns above this line. For all practical purposes you may consider this almost a Law of Nature. Consistent returns above the line just don’t happen.

On the other hand, it’s perfectly possible to generate returns far below the line. Many investors end up far below what they should have earned given the level of risk that they assumed. Indexed linked annuities give you an opportunity to do just that. But, of course, you will have the satisfaction of knowing that your agent and his company are benefiting richly while taking no risk at all.

FINRA’s investor protection alert, Equity-Indexed Annuities—A Complex Choice, points out that among other problems depending on the specific market conditions an investor may earn far less than she might with a fixed annuity in a poor market while profiting far less than the return of the underlying index in a good market. For instance the downside protection guarantee might be 85% of the purchase amount plus 1-2% per year. So, the total return might be less than zero over the contract life. Even this meager protection disappears in the event of premature surrender. Meanwhile upside potential is severely limited by fees, caps on performance, and the failure to include dividends the index earns as part of the calculation.

The equity indexed annuity contract is so complex that I would be surprised if one investor in a thousand understood it. Worse yet, I doubt that one annuity salesman in 100 understands it beyond the talking points he is supplied with. One thing they invariably do understand is that the product pays far higher commissions than other available choices. So, we shouldn’t be surprised that a highly motivated commission driven agent can make that product stand up on the table and dance.

It’s expensive to get substandard products. The market offers far more effective, economical, tax efficient and straightforward solutions. The siren song of downside protection with upside potential comes at tremendous cost.

Investors would be far better off to limit their downside exposure by trimming their global equity holdings to an amount that meets their risk tolerance and investing the balance into a quality short term bond fund. Then they should expect to be fully rewarded for the risk they can bear while sleeping comfortably at night with a comfortable cushion of fixed income assets.


2 weeks ago

Khazanah throws MAS RM6b lifeline

Aug 29 2014 5:01pm CDT | Source: Business Times Singapore

August 30, 2014 1:15 AMKHAZANAH Nasional will inject RM6 billion (SS$2.4 billion) over three years to resuscitate loss-making Malaysia Airlines (MAS) under a recovery plan that includes even an Act of Parliament. Other key moves are migrating its operations, assets and liabilities to a new company (New ...
Source: Business Times Singapore   Full article at: Business Times Singapore


3 weeks ago

MAS posts loss of RM307m for Q2

Aug 28 2014 5:00pm CDT | Source: Business Times Singapore

August 29, 2014 1:13 AMMALAYSIA Airlines (MAS) registered a loss of RM307 million (S$122 million) for the second quarter to end-June, but warned of worse to come in the second half when the "full financial impact of the double tragedies o ...
Source: Business Times Singapore   Full article at: Business Times Singapore


Don't miss ...


<a href="/latest_stories/all/all/30" rel="author">Forbes</a>
Forbes is among the most trusted resources for the world's business and investment leaders, providing them the uncompromising commentary, concise analysis, relevant tools and real-time reporting they need to succeed at work, profit from investing and have fun with the rewards of winning.


blog comments powered by Disqus

Latest stories

Smoking causes urological diseases
Vienna, Sep 19 (IANS) Smoking leads to a number of urological diseases, experts said.
'Angelina Effect' makes more women test for breast cancer
Islamabad, Sep 19 (IANS) At least three militants were killed Friday in a remote-controlled blast in Pakistan.
Want good raise at work? Get a supportive wife
New York, Sep 19 (IANS) Do not just blame your boss or jealous colleagues for no promotion or salary hike at work - your spouse's personality is equally important to decide if your chosen career will make you richer or poorer.
People with larger pupil size bad decision makers
London, Sep 19 (IANS) People with larger pupil size tend to be inconsistent in their decisions, says a study.

Latest from the Network

Katherine Heigl on 'apology tour'
Katherine Heigl is on an ''apology tour''. The 35-year-old actress was the subject of a Hollywood Reporter expose on her alleged diva behavior a year ago but her 'State of Affairs' co-star David Harbour says she is now...
Read more on Celebrity Balla
Ryan Gosling 'madly in love' with daughter
Ryan Gosling is ''madly in love'' with his baby daughter. The 33-year-old actor and his long-term girlfriend Eva Mendes welcomed their first child into the world last Friday (12.09.14) and the couple are both said to...
Read more on Celebrity Balla
Simon Le Bon can't get his kids to move out
Simon Le Bon can't get his children to move out. The Duran Duran star has daughters Amber, 25, Saffron, 22, and Tallulah, 20, with supermodel wife Yasmin Le Bon and he's confessed that although they have all grown up...
Read more on Celebrity Balla
Kim Kardashian West vying for Downton Abbey role
Kim Kardashian West wants to star in 'Downton Abbey'. The 'Keeping Up with the Kardashians' star is reportedly desperate to land a role in the ITV period drama, and resorted to seeking advice from Laura Carmichael, who...
Read more on Celebrity Balla
Prince Harry transformed into a puppet at birthday bash
Britain's Prince Harry was transformed into a ventriloquist's dummy at a party for his 30th birthday. While the flame-haired royal was initially reluctant to get on stage during the bash at Clarence House, he was...
Read more on Celebrity Balla
Daniel Radcliffe visits marijuana cafe
Daniel Radcliffe visited a marijuana café in Amsterdam. The 'Harry Potter' actor decided to stop by one of the famous cafes while visiting the Dutch capital and was seen looking very pleased with himself as he posed for...
Read more on Celebrity Balla
Iranian hardliners form 'chastity patrols'
Tehran, Sep 19 (IANS/EFE) "Chastity patrols", created by an Iranian paramilitary group, are patrolling the streets of Iran to force women to go "well covered" in public. At the beginning of summer, trendy Iranian...
Read more on Politics Balla
Sophia Loren celebrates 80th birthday with an exhibition
Los Angeles, Sep 19 (IANS) Italian actress Sophia Loren, who will turn 80 Saturday, will celebrate her birthday with an exhibition displaying her most prized possessions in Mexico. The Oscar winner's belongings,...
Read more on Celebrity Balla
Liam Neeson scared of heights
New York, Sep 19 (IANS) Actor Liam Neeson may be known as a action star, but there is one thing that terrifies him: Heights. The 62-year-old actor admits he suffers from acrophobia and can't even manage to stand on a...
Read more on Celebrity Balla
Jeptoo targets history in Chicago Marathon
Nairobi, Sep 19 (IANS) History will be beckoning for Boston Marathon champion Rita Jeptoo of Kenya when she lines up at the Chicago City course for the 42km race Oct 12. Jeptoo is chasing her maiden win in the World...
Read more on Sport Balla