Biggest Annuity Investment Mistakes

Investing is never a precise activity. No matter the investment vehicle, there are usually a number of variables that have to be identified, weighed, compared, and, ultimately, matched to your investment objectives, and nothing ever fits precisely. And, periodically mistakes are made when choosing an investment. Mistakes made with annuities can be especially costly because they involve a contract that makes it difficult to rectify an error or appease a change of heart. Clearly, annuities aren’t for everyone, but in the right circumstances, for the right person, they can be just the right investment. That can only happen when you go into an annuity investment with your eyes wide open, and you know how to avoid the biggest annuity investment mistakes.

Annuity Investment Mistake #1: Investing without clear, well-defined investment objectives

This would be considered a bad mistake for any type of investment, but, with an annuity, it can have more far reaching, and longer lasting consequences. Annuities can address several different investment objectives, and the different types of annuity products are designed for different investor profiles. It’s likely that among the many types of annuity products there’s one that can match most any profile. But, unless you have a clear understanding of your profile, and you specifically define your objectives, you may never really know if it is the right investment for you. And, of course, this can lead to remorse, angst, and, ultimately dissatisfaction with your investment choice. It is vital that you take the time and effort to clearly define your investment profile and objectives before investing.

Annuity Investment Mistake #2: Investing in a product you don’t understand

This one of Warren Buffets top 3 investing tenets: Never invest in what you don’t fully understand. He applies his warning to stock investing and the importance of truly understanding the business, what it does and how it makes money. With annuities, you need to understand the product, how it works, and how it specifically addresses your financial needs. Even the most basic of annuities, the immediate annuity, which is a simple exchange of capital for a stream of income, has a lot of moving parts which are consequential. Variable annuities have an added layer of complexity with their investment accounts and additional costs. And, indexed annuities are especially complicated with their formulas and caveats. These can all be exceptional products, but if you can’t clearly explain how they work and how they address your specific needs so that a high school student can understand it, you need to study them some more.

Annuity Investment Mistake #3: Investing without an overall strategy

One of the worst mistakes investors make is to make investment decisions without having a guiding strategy based on their objective, needs, concerns and risk tolerance. Investing by making ad hoc decisions or without consideration for a strategy almost never works in favor of the investor. With annuities, people often make the mistake of buying them without considering their liquidity needs, or tax situation, or their participation in qualified retirement plans. Any investment should fit snug alongside other investments in a portfolio designed to achieve the broadest diversification and balance. Annuities should not be considered unless you have sufficient liquidity with other assets, and your tax situation merits investing in tax advantaged investments. Above all, until you have maximized your retirement plan contributions, especially where employer matches are available, an annuity may not be appropriate for your portfolio.

Annuity Investment Mistake #4: Buying the first annuity you see

For most annuity owners, their first encounter with an annuity product was through an agent or advisor who recommended it. In most cases, that agent or advisor recommended a particular product because it was the only one, or one of a small number, that they offered. This is not to say that they recommended a bad or non-competitive product, but how would you know unless you were able to compare it against others. There are hundreds of annuity providers each offering several different products. The good news is that it is a very competitive marketplace. Once you learn more specifically how annuity products work (see Mistake #2) including how rates are determined, costs, fees, withdrawal provisions, etc., you can use all of these as points of comparison. The best way to do this is by accessing an annuity comparison site. It can take just a matter of minutes to screen through dozens of products using a range of different criteria.

Annuity Investment Mistake #5: Going for quantity over quality

When comparing annuity products, the big draw are the yields. Annuity providers know that they may have only one, brief opportunity to lure you in, so they use their most effective marketing ploy which is a high promotional rate. Certainly the appeal of an interest rate that is a point higher than the next competitor is difficult to overcome. And, with indexed annuities, the products that offer 100% participation rates or 0% cap rates have tremendous allure. But there’s two very important considerations in choosing rates: First, look under the hood. A high promotional rate today may turn into a below market rate shortly down the road. Second, annuity providers that offer the highest rates might need to do so because their ratings are not the best. And, companies that get too aggressive in their rates can weaken their financial position in the future.

Going way back in history to the 1980s may be too big of a stretch considering that there hasn’t been a failure of a life insurance company since then, but it is worth noting that companies, such as Baldwin United and Executive Life offered the highest rates of the day, but their portfolios also had the lowest ratings. This made them very susceptible rising interest rates which wiped out a chunk of their portfolio value. Both went into receivership, and, although all of their contract holders were made whole, it served the purpose of illustrating why it is important to go with quality over quantity by choosing the life insurers with the strongest ratings.