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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...

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17 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.

 
Update
10

7 weeks ago

RM47mil KWSG contributions still unclaimed

Jun 9 2014 7:54am CDT | Source: Business Times Malaysia

KUALA LUMPUR: About RM47 million of contributions in the Teachers Provident Fund (KWSG) still remain unclaimed, the Dewan Rakyat was told ...
Source: Business Times Malaysia   Full article at: Business Times Malaysia
 

 
Update
9

7 weeks ago

Gold shop lost almost RM1mil

Jun 9 2014 3:50am CDT | Source: Business Times Malaysia

KANGAR: A gold shop owner lost almost RM1 million after after the safe on in his shop was broken into by robbe ...
Source: Business Times Malaysia   Full article at: Business Times Malaysia
 

 
Update
8

7 weeks ago

Motion to debate MAS losses in Dewan Rakyat rejected

Jun 9 2014 3:39am CDT | Source: Business Times Malaysia

KUALA LUMPUR: AN emergency motion to debate the losses incurred by Malaysia Airlines last year, amounting to RM1.2 billion was rejected by the Dew ...
Source: Business Times Malaysia   Full article at: Business Times Malaysia
 

 
Update
7

7 weeks ago

MH370 Tragedy: Hisham: RM27.6 mil spent on 1st phase of SAR

Jun 9 2014 2:11am CDT | Source: Business Times Malaysia

KUALA LUMPUR: Malaysia spent some RM27.6 million in its first phase of the search operations for missing Malaysia Airline flight MH370, said Acting Transport Minister, Datuk Seri Hisham ...
Source: Business Times Malaysia   Full article at: Business Times Malaysia
 

 
Update
6

7 weeks ago

9.1m litres of diesel seized in a month

Jun 8 2014 1:11am CDT | Source: Business Times Malaysia

PUTRAJAYA: The Domestic Trade, Cooperatives, and Consumerism ministry has seized some 9.1 million litres of diesel and property worth RM58 million since mounting ‘Operasi Diesel Selatan’ in the southern states last month. ...
Source: Business Times Malaysia   Full article at: Business Times Malaysia
 

 
Update
5

8 weeks ago

Girl, 9, awarded RM2.78m compensation for medical negligence

Jun 6 2014 4:56am CDT | Source: Business Times Malaysia

KUALA LUMPUR: A nine-year-old girl who suffered brain damage during her birth at a government hospital was awarded over RM2.78 ...
Source: Business Times Malaysia   Full article at: Business Times Malaysia
 

 
Update
4

8 weeks ago

Malaysia's total trade in April up 12pc

Jun 5 2014 11:52pm CDT | Source: Business Times Malaysia

KUALA LUMPUR: Malaysia's total trade in April 2014 rose by 12 per cent from a year ago to RM123.86 billion due to growing trading activities, International Trade and Industry Minister ...
Source: Business Times Malaysia   Full article at: Business Times Malaysia
 

 
Update
3

8 weeks ago

Works Ministry to spend RM20m for upgrading works at 50 accident black spots

Jun 4 2014 11:35pm CDT | Source: Business Times Malaysia

JOHOR BARU: The Works Ministry will implement upgrading works at 50 accident prone locations in the country that have been identified this year involving an allocation of RM ...
Source: Business Times Malaysia   Full article at: Business Times Malaysia
 

 
Update
2

8 weeks ago

Najib launches loan scheme for Ramadan traders

Jun 4 2014 10:24pm CDT | Source: Business Times Malaysia

PUTRAJAYA: Prime Minister Datuk Seri Najib Razak today launches RM45 million Ramadan Bazaar Scheme 2 ...
Source: Business Times Malaysia   Full article at: Business Times Malaysia
 

 
Update
1

8 weeks ago

Residents bring up objection against Kidex to Suhakam

Jun 4 2014 4:49am CDT | Source: Business Times Malaysia

PETALING JAYA: A group of 20 Petaling Jaya residents held a meeting with the Human Rights Commission of Malaysia (Suhakam) over their objection against the proposed RM2.2 billion Kinrara Damansara Skyway (Kidex) today. ...
Source: Business Times Malaysia   Full article at: Business Times Malaysia
 

 

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