Retirement Candy: Sweet Temptations That Lead to Hard Crashes
Key Takeaway: Strategy should always take precedence over tactics. This is especially true with all the investment solutions being touted as the answer to people’s main fear: losing money. However, too often, a product is purchased without understanding how it fits into the broader strategy of a retirement plan. And some of those products are not what they seem to be.
With the markets reaching all-time highs, the peddlers are out. You see them on cable television as they hock precious metals, in insurance ads as they hock a safety of principal (annuities), or in blogs and podcasts about using certain products to “guarantee” outcomes. It is natural for people to be drawn to certain retirement products that promise instant gratification. Much like candy, these products offer a temporary sugar high but can cause a significant crash if not handled wisely. Let us explore three such tempting yet not-what-they-seem retirement products.
1. Annuities with Aggressive Riders
I will give you the punch line up front: Most people never annuitize their annuity. In the right situations, an annuity could make sense. But I often see annuities sold with special riders that make them expensive from a fee perspective, particularly since those riders rarely get used if you don’t annuitize the contract. And these high fees just eat into the performance of the product.
I say all this knowing that annuities are not all bad. The largest annuity out there is Social Security, and it provides income to millions of retirees. But if you think about it, Social Security does not have a layer of fees to it as a product.
The Sugar Crash:
The added costs of these aggressive riders can erode the overall value of the annuity. Moreover, the conditions attached to these benefits might be so restrictive that they rarely, if ever, apply. Retirees may end up paying for features they never use, reducing their overall retirement income. It is essential to thoroughly understand the terms and weigh the costs versus benefits before opting for such riders.
Secondly, annuities are sometimes sold inside an IRA. However, an IRA is already tax-deferred, so you do not need the tax deferral of an annuity; it just adds fees, particularly when you do not annuitize the annuity, as I already mentioned.
2. Non-Traded Real Estate Investment Trusts
Real estate investment trusts (REITs) are often touted as a way to diversify a retirement portfolio with real estate without the hassle of owning physical property. They offer attractive dividends and the potential for capital appreciation. However, not all REITs are created equal.
Non-traded REITs (as opposed to traded REITs on a stock exchange) can be illiquid (usually you can only get money out quarterly or annually), be difficult to value (the underlying property values do not change quickly on your statement), and have high upfront fees.
The Sugar Crash:
The lack of liquidity in non-traded REITs means retirees might struggle to access their funds when needed. The high fees can significantly reduce returns, and the difficulty in accurately valuing these investments can lead to surprises when it’s time to sell.
Inherent in the lack of liquidity issue is timing. Many non-traded REITs talk about having ultimate liquidity on your funds at some point in the years ahead. The problem arises when that future date coincides with a real estate downturn and the REIT decides to keep going for many more years versus selling in a downturn. Your cash can get locked up for a long time.
3. Downside-Protected Investments
Protection against uncertain markets (fear sells) is now a niche in the financial industry. These products could be exchange-traded funds (ETFs), structured notes, or mutual funds. They use options to protect an investment (usually a basket of stocks) from some or all of the market’s downside. Some can refer to the fact that they might allow your investment to participate in some but not all of a market drop.
The Sugar Crash:
The downside protection in these investments usually means sacrificing some of the upside potential (buying options is a cost—so to buy options to protect the downside, these investments often sell options giving away some upside to offset the costs). In bull markets, these investments can significantly underperform, leading to missed opportunities for growth.
The complexity of the formulas used in this protection can also be problematic. The mechanics are often not as simple as where the market ends up versus where you purchased the investment. This is a critical point because it is important to understand if the potential upside returns do not even get hit and that impacts your retirement plan.
The complex strategies employed can also result in higher fees, further eroding returns. While these types of investments may seem logical in a short-term, volatile market, they often detract from the growth needed in a long-term retirement plan.
The Real Problem
The real problem with all the products I list above is not the product; it is the lack of strategy. When we work with clients, we look at a couple/family as a household and develop an investment strategy for the household. Then, we tactically make investments that fit the household based on risk, return, fees, spending needs, taxes, and types of accounts they hold (for example, riskier assets held in Roth IRAs to try to grow those accounts faster).
Compare that to what many people do. Instead of a broad strategy as the first layer, many simply buy individual products that sound interesting in the moment but lack the total portfolio fit. It is like going to a grocery store without a shopping list and simply throwing things that look good into the cart; you then get home with a lot of groceries, but nothing really fits into a recipe.
By being aware of these potential pitfalls and working with a trusted advisor, you can create a retirement strategy that helps provide the security and peace of mind you deserve. After all, true financial health is built on solid, well-informed decisions, not quick fixes and fleeting highs.
The opinion of the author is subject to change without notice and must be considered in conjunction with relevant regulation, as well as subsequent changes in the marketplace. Any information from outside resources has been deemed to be reliable but has not necessarily been verified. Each individual has unique circumstances to which this information may or may not be relevant. Under no circumstances will this information constitute an offer to buy or sell and it does not indicate strategy suitability for any particular investor.
