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Richard Hoe joins Coach Pete to discuss financial planning and why one product cannot fit every investor. Their November 2011 conversation explores annuities, income riders, costs, and choosing an approach that fits a person’s needs and risk tolerance.
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Transcript
Automatically transcribed from this episode; timestamps are approximate.
00:00 In this FinancialSafari.com interview from November 2011, Coach Pete interviews Investment Advisor Representative Richard Poe. And welcome back into the Financial Safari. And as we like to do each and every week, I like to pull in a national expert, somebody who is out there in the financial world, folks, and understands everything that's available out there to the general public, but more importantly, someone who can educate you a little bit on the process of financial planning. And we're very lucky this week to have an individual who's been in the financial arena for at least 43 years. His name is Richard Ho. And he has also been writing articles, he said, for longer than he's been in the financial world.
00:46 He's an investment advisor representative. And Richard, I wanted to talk to you about how the fact of in the financial world, there's not one product that's the right fit for everybody. Correct? Correct. Absolutely correct. And welcome into the show, by the way, Richard. Thank you very much, Coach. And so there's, I guess we'll talk about some of the confusion that exists out there. I mean, you need to put a plan together first, folks. And then there's different vehicles out there. There's something called an annuity, Richard. And let's educate folks on the different kind of annuities and how they may fit some of the people listening. Well, that sounds like a great idea. Essentially, in an average financial planning practice, there are probably three types that are most widely used. The variable annuity, which I also sometimes call an investment annuity.
01:36 And basically, that's a kind of a wrapper, Coach Pete, that surrounds a bunch of investment accounts that aren't really exactly mutual funds, but they're somewhat similar to mutual funds. Let me give you an example. If one of those accounts was, let's say, and I'll pick this out of thin air, Invesco balanced risk allocation, it would be managed by the same people that manage the Invesco balanced risk allocation mutual fund, but it wouldn't be exactly the same. It would be close. And its philosophy, investment philosophy, would be about the same. So that variable or investment annuity might have 30 or 40 of those subaccounts that are somewhat like mutual funds,
02:26 but not exactly in it. I mean, I even know of one variable annuity that has over 300 of those subaccounts, and they'll be from different mutual fund families, like you might have in one of those, some from Fidelity and some from American Funds and some from Invesco and so forth and so on, and Franklin Templeton and what have you. So it allows a person to access a variety of investment subaccounts that are mutual fund-like in one wrapper. So that's an advantage. The disadvantage is they have fairly high expenses. Another advantage to it, Coach Pete, is that they provide a very easy way to rebalance.
03:13 Rebalance. So rebalancing is important in the investment business, because if you start off just, say, 50-50, and you had 50% in a subaccount that was the Vanguard S&P 500 and 50% in a subaccount that was somewhat similar to a bond mutual fund, at the end of a certain period of time, let's say a quarter, there would no longer be 50-50. Correct. One of those two would do better. You know that. So, well, one advantage in a variable annuity is they'll rebalance for free. The expenses are higher, but they'll rebalance to your kind of risk tolerance every quarter. So that's an advantage. And they have some tax advantages in that, you know, that you don't have to pay tax while you're accumulating money,
04:01 and you have to kind of weigh that against the higher expenses. Then we have the traditional single premium immediate annuity, which is absolutely nothing like what I just described. It's a million miles away. A single premium immediate annuity is a contract between any natural person and an insurance company. And the natural person, which could be you or it could be me, gives the insurance company, let's say, $100,000. And the insurance company then promises to pay that person, or it could be two people, could be a husband and wife, pay them, let's say, $800 a month for the rest of one life, for the rest of two lives.
04:47 And insurance companies are very, very good at that. That's a contract. And if you do it on a non-qualified basis, meaning it's not an IRA or not out of a 401K or anything, it has some very good tax advantages as to the monthly income stream. So you have the assurance that if you enter into one of those contracts, that you're going to have income for the rest of your life. And it's going to work pretty well, Coach Pete. I don't know if you agree with me, but if you were to look at kind of a curve, when someone's 65 and retires, they tend for the first 10 years or so to spend more than they do for the balance of their life. So from 65 to 75, let's say, and I'm not saying anyone should retire at 65.
05:35 I certainly didn't. But if you did, if you looked at people like that, they tend to go traveling from 65 to 75. They tend to do a lot, maybe buy a vacation home. They tend to do a lot of different things, and they tend to spend more money. But they start to slow down when they're 75, 76, 77. They don't travel as much. They don't spend it. This is a generalization. I mean, I've got two customers who are 89 that travel more than anybody I've ever seen in my life. But generally. You know how that goes. And then there's a third kind of annuity that's very popular. We could call it, Coach P. We could call it the seminar annuity. And that's an annuity that is referred to as an indexed annuity. It's a little bit like the investment annuity, except the insurance company has a lot more control
06:26 over how the money's invested and if there are restrictions on it. Now, two of these annuities that I talked about, well, three really, but the investment annuity and the indexed annuity both provide income streams that are lifetime income streams. Now, we know that the single premium immediate annuity does that. That's a contract between you and the insurance company or me and the insurance company or anyone in the insurance company where you give them $100,000 or some amount of money, and they guarantee an income for life. But you can also kind of have your cake and eat it, too, in the variable investment annuity and in the indexed annuity in that the companies will also promise you a lifetime income stream in those two as well.
07:18 It will typically be less, less money, but you also have the ability to grow money in the market because of the underlying account. Have I done a pretty good job of confusing you? Not me, but, you know, here's one of the things I've seen. Annuities are sort of like cars. They seem to have some improvements every couple years or at least some new bells and whistles. But maybe you'll agree with me on this. One of the best inventions in the annuity world that I've seen is something called an income rider attachment the last five years or so. Do you want to explain to the listener what an income rider attachment is and what's the advantage of having an income rider attached to your annuity? That's a very good thing you brought that up, and I was trying to explain it, but you made it simpler already.
08:04 Yes. If you have either an indexed annuity or a variable investment annuity, you may acquire an income rider. It costs extra money. There's no such thing as a free lunch. And there's income riders that work during the accumulation phase, which is before you retire and start to take income. And then when you begin to take income, they promise that you will receive no less than, say, 5% income for life. So let's take an example. In year one, you put in $100,000, Coach Pete. Fair enough? Yep. Okay. Ten years from then, this company, we'll call them Company X, guarantees that you'll have for income purposes. I'm not talking about money now.
08:51 I'm talking about income purposes. They'll guarantee you'll have no less than $200,000. Nobody's saying how much money there's actually going to be in that contract. It could be $150,000. It could be $125,000. It could be $180,000. It depends on how the market does. If the market's really doing well, it could be $225,000. But let's say the market's not doing well, and it's either $150,000 or $175,000. So if you were going to cash it in, you'd get $150,000. For income purposes, that company promised you when you got that annuity that you'd have no less than $200,000 in 10 years. Fair enough? Fair. Okay. They also guarantee that if you start taking income and you're a 65 or some number, it's not always the same age.
09:36 But Company X is 65. You get 5% for the rest of your life. Company X also says that if you and your wife do it together, if there are two of you, you get 4.5% for life. So they have two promises there. And I kind of call that eyes wide shut. Not that it has any connotation like the Tom Cruise movie, which I think was one of the worst movies of all time, but that's a whole other story. But what I mean by that is if you focus on your income needs and you worry about the market every day, an annuity can relax you because it has that income promise. It may have that doubling promise in 10 years, which, by the way, is a compound rate of return of about 7.2%.
10:25 So on the income basis, or they call it an income base, basically they're saying no matter what the market does, we're going to promise that you double your money in 10 years for income. So if you don't pay attention to the basic underlying value, what I'm saying is that for some people it doesn't really matter because what they're interested in is income for life. And that may not be a bad deal. Now, if I can digress for one moment, I'll give you just a tiny little sermon, okay? If people get very nervous when the market goes down 30%, and I'm sure you discussed this a lot on your show, right? Correct. People don't think about investing reflectively.
11:13 Warren Buffett thinks reflectively about the market. People tend to be emotional about the market. And when the market goes down 30%, or sometimes even 10%, they just go wild. Now, you and I know that if you're in a good mutual fund, let me pick one out of the air that I'm not even using right now. We'll take an American fund, and it's one I happen to have approximate statistics for. It's a good fund. It's a balanced fund. It's got some bonds in it, usually, and it's got some equities in it, stocks. And it's kind of a mix, mostly American companies, but some that do international business. And they're very selective about bonds, and they have a good track record, okay? So if we were to look at them from, and I have to tell you, I kind of got ready for this show a little bit because I knew you were going to ask me some questions.
12:02 If we started 930 of 01, 2001, and we finished our 10 years at 930 of 2011, in some ways a pretty horrible decade, isn't it? It sure is. You had 2001, a lot of angst in 2001, a lot of angst in 2002. And the market really didn't start to perk up until about March of 2003. And it gave you the horrible 2008 year. And not only that, but we had the difficulty in July and August of this year. So there's a lot of bad stuff there. But if you were in this good mutual fund, and you looked at the numbers, if you took out 5% a year, which is 25, if you put $500,000 in, and you took 5% out of every year, and you took it out monthly,
12:52 so you're taking out 25,000 a year, comes out to about $2,066, give or take, a month. At the end of 10 years, the question is, how did you do? Now, remember, this is all predicated on picking a reasonably decent mutual fund that's balanced. I mean, I'm not suggesting you go out and invest 100% of your money in small cap growth or, you know, some other weird go-go thing. I'm suggesting that you kind of find a good balanced fund with a good history and good management. Now, so you would have received $25,000 a year for 10 years or $250,000. You started with $500,000. How much is left after you've taken all that money out? And the answer is about $548,000.
13:38 But here's the thing, Coach Pete. In 2008, that fund was down about 30%. And you might have gone out of your mind with worry. And if you did, you wouldn't be thinking reflectively. You'd be thinking emotionally. You'd be listening to the media. You'd go nuts. And if you were built that way, then maybe an annuity is a good product for you because you won't have to worry about lifetime income. I'm not saying it's perfect. I'm not saying you should put all 12 of your eggs in the one carton. I'm just saying that it might take a little of the steam out of your emotional reaction to the ups and downs of the market. Does that make sense?
14:25 It sure does. I mean, people need to insulate themselves a little bit. Yeah, but you and I both know that you would have been okay with that fund. You just have to think reflectively. But if that 30% is going to drive you nuts, you probably don't belong in that fund. You're right. I mean, and that's it. I mean, everybody has to think about that. I mean, the genius of Buffett is that he thinks very reflectively. You may not agree with how he thinks about taxes. I'm not sure. I love Warren Buffett, but I'm not sure he thinks reflective when he makes out his tax advice. But the man's a genius when it comes to thinking reflectively about investing. He doesn't panic like a lot of us do. So he says to himself, okay, this is a good manager.
15:12 This is a good company. This is going to be okay. They're having a rough patch. But let's look. They've had rough patches before, and they've done very nicely. If you can think that way, then you belong in a fund or in a portfolio of stocks and bonds. If you can't deal with that, then you belong perhaps in an annuity with part of your money. Well, great point, Richard. And we've got about 30 seconds left. And let me just see if I can get you to agree or disagree with this. I mean, is it a correct statement for me to say that nothing is for everyone in the financial world? Yes, sir. Yes, sir, a thousand times. Folks, that's been Mr. Richard Ho. He's an investment advisor representative. He's got over 43 years' experience in the financial world.
15:58 And, Richard, I hope we can have you back on again in the future on the Financial Safari. Coach Pete, it was a great pleasure. Thank you very much. Thank you so much for listening to this interview on the Financial Safari. Remember, folks, if you have any questions about this interview or your financial situation, you can email the team from the Financial Safari at comments at financialsafari.com.
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