Cracking the Code

In a post from a few weeks ago I was discussing how important it is to know the code words some advisors use when they are selling their products and services. By understanding how these words are used you can get a pretty good sense of what the advisor's agenda is, the kinds of products they're selling, and the kinds of services you're likely to receive. The post stemmed from catching a financial radio broadcast while cruising through the central valley and scanning local radio stations.

I had wanted to follow up on this post and, as luck would have it, I was driving through the area again over this past weekend and caught another radio show from a different advisor. Sure enough, after a couple of minutes the code words started to pop up all over the place. Safety, income planning, discussion of market collapses and securing retirement income led to "education" about annuities.

Interestingly, it turns out the advisor educating listeners doesn't have any specialized credentials and isn't even a Certified Financial Planner. Additionally, the advisor seems to be registered with only one insurance company and acts as an agent for a couple other firms. How much meaningful education could be had from such an advisor? More on that later.

Now, as many of you have heard me say in the past, annuities aren't necessarily all bad. They can be useful tools in the right situations and if purchased under favorable cost structures. The problem with annuities is that most of them are way too expensive, way too complicated, and pushed way too hard by the brokers who sell them.

The importance of this latter point is easy to underestimate. As mentioned in that prior post, investors often hear local advisors on the radio, at a free lunch or dinner seminar, or elsewhere, and it can be very, very hard to understand what the advisor's agenda is. The advisors can be so nice, so folksy, and sound so trustworthy that investors often end up buying complicated and expensive annuity contracts without even realizing it. I've even sat through a whole presentation that was all about annuities without the word ever being used. Instead, it was all code words and doom and gloom about market collapses and securing income in retirement. Some advisors are just that slick.

So how does an investor figure out the advisor's agenda? Ideally, it would be as simple as calling up and asking but that often leads to more gobbledygook. Instead, listen for these code words and consider the descriptions that follow. Now, this isn't to say that every advisor who emphasizes these words has complicated ulterior motives, just that it's more likely.

"Safety, Security, Protection"

What's wrong with these words? Nothing, except that advisors will often wax poetical about how annuities can make one's retirement years safe, secure, and protected in a terrifying world filled with economic collapses and market meltdowns. But the reality is that all investments carry risk and investors are compensated for this by earning a return on their investments over time. Low risk investments earn the least while higher risk investments come with higher expected returns. This is intuitive but many advisors imply that with fancy annuity contracts you can have your cake and eat it too; you can earn enough to have a "safe" retirement without having to take on much market risk.

The advisor I heard on the radio made a gross misstatement about the risk of annuities compared with other investments. Speaking about the 2008 market collapse the advisor said that while other investments were falling by 20, 30, or even 50%, variable annuities would have only fallen by the withdrawal charge required to close the contract early (the advisor said 10%). The advisor implied that the investor could get their original principal back at any time, less the penalty, even if the contract's market value had declined. Your annuity loss in 2008 would have been 10% while your neighbor's retirement account dropped 40%, the advisor opined.

This is 100% false but is something I've heard countless times from brokers and their customers. While the reasons for this are beyond the scope of this post, the primary way to get your money back when your annuity's market value is below your original investment is to die. Seriously. There is no free lunch in the world of investing.

"Income Planning"

Now, planning for income in retirement is a fundamental component of financial planning. This is based on comparing known income sources, such as Social Security, against known expenses, looking for holes, and then planning for how to fill them. Somewhere along the way brokers co-opted this fundamental process to sell annuities. They know that pre-retirees and retirees are understandably sensitive about their income in retirement so they figured out if they sell annuities as "income solutions", focusing on this one component and glossing over the rest, they'd have lots of willing customers.
This has become so prevalent that I assume most brokers don't fully understand how the contracts they're selling actually work. They know how to sell income benefits and that's about it. Income benefits, by the way, are often added as "riders" on top of annuities that are, fundamentally, insurance contracts.

Some brokers go as far as crafting "retirement income plans" for their customers. These plans are often referred to as financial plans but they are far from it. Serving more as a "needs analysis" to help determine how much a customer should invest into an annuity, the plans are a means to an end.

I took some time to look up the advisor who was on the radio and reviewed the firm's website. Income planning was one of the services listed. After looking around the site for a while and through a variety of regulatory disclosure documents, I can only assume this service is a needs analysis leading to a recommendation to buy an annuity. As mentioned previously, and maybe unsurprisingly, the advisor isn't a CFP and, after reading the bios of the others at the firm, nobody else is either. References to planning could, and maybe should, be replaced by "selling". Income selling. There might be fewer buyers but at least it would be more transparent.

So, should you be listening to financial radio or attending a free lunch or dinner presentation, have your antennae up for these code words. When you hear them ask some probing questions about what the person is promising, what the costs are, and what the advisor's commission would be should you follow their advice. The responses are often interesting and could save you a bunch of money in the long run.

Have questions? Ask me. I can help.