Financial products are sold with ferocious passion at all times, but especially during down markets. But are these products good? We refer to the old saying: caveat emptor, buyer beware.
Financial companies love to prey on people’s fear of the stock market. Never let a good crisis go to waste. The marketing of products by banks and insurance companies goes way up during a turbulent market. Should you buy these products?
When we talk about products, we are not talking about accounts. Roth IRAs, 401(k)s, HSAs, and the like are not products. They are account types. When we say products, we are generally talking about insurance company- or bank-produced products such as annuities, CDs, CDOs, cash-value insurance policies, and the like. Should we buy them?
This first principle is this:
Good strategies and behaviors beat financial products 95% of the time.
Financial products have too much overhead and too many guarantees built into them for them to be good for the customer.
What about the 5%?
Products You Need
If you’ve got young dependent kids and you are working to earn an income to provide for their needs, there is no strategy that is going to make up that income if you pass away. There are no accounts you can save into or investment strategies that will reproduce your income for the years it will be required. That is why you buy a product: level term insurance. I have two kids. I have $2,000,000 in term insurance.
Further, if you have a family that depends on your income and you become sick or unable to work, your retirement accounts are probably not ready to generate income for life. You need to buy a product: long-term disability insurance. I have group insurance and an additional individual disability policy to ensure complete coverage.
If your $300,000 house burns to the ground, no strategy will replace it. You buy a product: homeowner’s insurance.
If you get in a car accident where you are at fault and inflict $800,000 of damage, your discount auto insurance covering $300,000 isn’t very helpful. And there is no strategy for making up that other half-million you will owe.
You do need to buy basic insurance products to cover your weak points. We covered this in episode 20, Insurance You Do & Don’t Need.
The basic products are good. It is when they start getting fancy that you should beware.
Products to Beware Of
Beware of any products that try and do more than one essential thing. Don’t cross your investments with your liability. Let’s look at a few principles.
Hallmarks of a Bad Product
There are some dead giveaways that a product is poor.
Products often have low single-digit returns. Some products, like cash-value life insurance, have negative returns for years before they turn positive. A small portion of your money in flexible fixed income is encouraged in many cases, but you shouldn’t want this to be the case for most of your money. This is especially damaging when you combine it with the next hallmark.
Locking Up Your Money
Most products lock up your money for a period of time, often called a surrender period. If you pull the money out before the end of the period, you will have to pay a surrender penalty, often between 5%-12% of what you put in. Your money may be locked up for up to 10 years!
And people sell this garbage! Why would you want low returns for long periods? Take the typical seven-year surrender period. You might be offered a fixed or fixed-indexed annuity that promises or will average 3-4% per year over seven years, a 20-30% total return over the seven years.
If you don’t need the money for seven or more years, why would you only want 3-4%? That’s what you want on short-term money, not mid- to long-term money. At 10% average equity returns, your money would double over seven years, a 100% return.
And as of this writing, with the S&P temporarily down around 24% from its all-time high, it will return 30% just to recover. Do you think it will take seven years for the market to recover? So if all you want is 30%, why would you lock it up for seven years to get there. There are better, more flexible ways to do with strategy.
Financial products are extremely profitable for the insurance companies, and they can pay fat commissions to their representatives to sell them. That’s 50-100% of the first year’s premium on insurance policies, and 3-10% of the total premium on annuity products.
If you get sold an insurance policy at $500 per month, the rep will get paid $3,000-$6,000 to sell that to you. Sure, they’ll make those percentages on term insurance and disability too. But there is a big difference between a $6,000 commission on a lousy hybrid of insurance and “investment” and a $600 commission on the full term coverage you need. Plus, if you’re only paying $50 per month, that will allow you to invest the difference.
If you get sold an annuity that you put $300,000 into because you cannot bear to see it temporarily dip in value, and that representative get’s paid 7% on that, they are making $21,000 to sell that to you. Are they selling it to you because it’s actually a great product? Or because they make a ton of money?
In addition to the commissions to the front-line salespeople, all these products have underwriting and administration costs that are very expensive and are produced by companies that will bake a healthy profit in as well. I’m not opposed to profit, but the total of all these lines of expense degrade your returns and flexibility over time.
You cannot build your fortune if all your money is going to products building theirs.
What products should you beware of?
Beware of These Products
People are particularly fleeing to annuities these days, and those are the primary ones to look out for.
These lock up your money with some of the worst returns imaginable. I have never seen an instance where someone should buy a fixed annuity. NEVER.
These products will often masquerade as investment products. They will tell you that it is indexed against the S&P 500 or other stock market indexes, but that they have a floor so that you can never lose money. We’ll do a separate episode sometime on these. But I would also never recommend these to anyone.
In particular, it is the fixed-indexed part of these that is no go. There are some indexed variable annuities that are not nearly as bad. The price return of these products will actually mimic the index and usually offer some downside protection with a high cap. But you do give up the dividends that the index pays by being in these products. So while the price return can be similar, the total return will still often be less.
While not as bad as fixed annuities, the fees on any annuity are ridiculous, and the “benefits” you get in exchange for those fees are not great. I talk about these in my book and elsewhere, but most annuities generate a flat income that is guaranteed for life and will halve in value over your lifetime as costs rise. They may also offer a guaranteed increase in value every year of 6%+, but that is generally only on the basis of that flat income. If you’re considering a variable annuity, I implore you to research other strategies before you buy these expensive products. The book is a good place to start.
Whole Life, Universal Life, Indexed Life, & Variable Life Insurance
We covered some of the problems with permanent life insurance in episodes 14-17 in our Life Insurance Lies series. In short, almost no one should own these. And if you do own these, you should get them evaluated.
Anything New and Shiny
Beware of any “new” or “improved” product. Insurance companies are coming out with new products and twists on old products all the time in order to boost sales. There is always a catch. Beware.
For example, I recently heard of a new twist on the venerable term life insurance policy. This company had decided that people can’t be trusted to get lump-sum insurance benefits. They claim that most people waste the money and don’t have the discipline to make it last, similar to winning the lottery. Their solution? Income term life.
Suppose you needed $1,200,000 in coverage. Instead of paying your family the full tax-free benefit if you die, they will pay them $20,000 up front for the funeral and then pay out the $1,200,000 in monthly installments over twenty years. $5,000 per month, tax-free. And, the premium is 20% less than the regular term! Sounds great, right?
You are giving up any, and all interest or investment returns you could have earned on that money over that time! It would be akin to sticking it in a savings account and pulling out the $5,000 each month. But since we can’t trust people to do that, we better do it for them.
Plus, $5,000 a month will not be worth $5,000 a month in 20 years. It will be cut nearly in half.
You should get the standard level term life insurance, and if you pass, the money should be handed over to a sound investment strategy. A good strategy, like 3D Retirement Income, can produce the same $5,000 per month, plus inflation raises as needed, forever. Why would you want a level income for only 20 years?
What a dumb product.
So as you build your financial plan, either yourself or with professional help, beware of bad products. If it’s fancy and complicated with lots of bells and whistles, it’s probably bad. Those who sell them are not required to act in your best interest.
If you own any financial products, get them evaluated by a Fee-Only Fiduciary. You don’t want to go to just any financial advisor to get a second opinion. If they work for an insurance company or broker-dealer, they will likely agree that your product is terrible and then recommend a different one that they claim is better (and will get paid on).
A Fee-Only Fiduciary Financial Planner is transparently paid only by you and does not sell nor receive any commissions or compensation on any financial products. If it’s genuinely in your best interest, they will tell you so because they must act in your best interest. But if there is a better strategy than a product, they will tell you that too.
You can find a Fee-Only Fiduciary near you at FeeOnlyNetwork.com. As always, you’re welcome to interview our team as well. As Fee-Only Fiduciary Financial Planners, we will always act in your best interest and give you comprehensive and unbiased advice on all financial topics.
Thanks for listening.
This article is educational only and is not intended to be investment, legal, or tax advice or recommendations, whether direct or incidental. Again, this is not investment advice. Consult your financial, tax, and legal professionals for specific advice related to your specific situation. Never take investment advice from someone who doesn’t know you and your specific situation. All opinions expressed in this article are the opinions of the people expressing them. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. RetireMentorship is not affiliated with any Registered Investment Advisor, Broker-Dealer, or other Financial Services Company.