Many reasonably rich people come and ask me one question: Should I buy an annuity?
My counter question is : Do you have enough money to afford an annuity?
The answer is Yes…but it means I will leave less money for my children..an annuity is such a poor yield..I can easily get 18% return on my equity funds why should I get stuck with a 6% p.a. product…Subra “I would only need a return of 13% on my investment portfolio to outperform purchasing an annuity today.”
The media has made a huge, huge, huge mistake called “choosing of end point mistake”. Let me explain. All returns – 1 year, 3year, 5 year….look good now SIMPLY because we have chosen Dec 2017 as the end point. If 2018 gives us a MINUS 20% return we will be staring at far worse numbers than what it looks today.
One of the mistakes I see people make is looking at a good return on a nearly risk-free investment (thanks to the smooth ride from 2009 to 2017 dec, as of now) and concluding that they would do better in the stock market because it has a higher long-term average return. So the sales guy tells him “we have got 18% return in the past 10 years so you will get at least 16% over the next 10 years, so break your fixed deposit and put it in a balanced fund which will give you a monthly dividend…AND CAPITAL APPRECIATION.
Long-term market return averages are GOOD ONLY when we have an investment portfolio that isn’t used to fund specific future liabilities or to meet SPECIFIC expenses.
When you want to use equity funds for intermittent withdrawal for expenses like marriage, education, vacation…etc. you run the SEQUENCE OF RETURN RISK. This is dangerous.
On the other hand, when we are saving and investing in stocks for a single future expense, like buying an annuity or paying for a wedding, we cannot (or may not) be sure that we will be able to sell the shares at the price needed to pay that liability when it comes due. So we tend to beat the sequence of risk BY SELLING when we can. We may know how much the wedding will cost and when it will be held but we won’t know the future value of our share investments until the day we want the money arrives. This is a “duration-matching”, or “liability-matching”, problem.
One of the investors wanted to put his money in an equity mutual fund and let it grow at 18% for 10 years..so that he can buy a PENSION at a later stage..I mean “safe” annuity. Sounds silly to me. You want a larger benefit to be bought at a later date, then does it make sense, to expose the assets you have earmarked for safe income to share market risk for four, 15 or any X number of years first?
What if you wipe out the principal? I am sorry but when the market is not seen bad times for 9 years, they think bad times will not happen. Wrong.
It’s like saying I need Rs. 10,00,000 for my daughter’s marriage in 2020. Right now I have only 200,000 Rs. Let me go to the races (or day-trading) so that I can make this 12,00,000 in 2 years so that I can have a grander marriage.
All the best. God bless.
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