Don't let it get away!
Keep track of the stocks that matter to you.
Help yourself with the Fool's FREE and easy new watchlist service today.
In a topsy-turvy market, being cautious about your investments is second nature. But most investors try to protect themselves against the wrong kind of risk in volatile markets. Rather than worrying about short-term bumps in your investment returns, the real danger to your portfolio lies in the temptations that threaten to derail your entire investment strategy -- temptations that some professional advisors promote for their own gain.
Fortunately, there are some simple steps you can take to orient your cautious nature in the right direction. You'll learn about them later in this article, but first, let's explore some of the ways that you can get waylaid on the path to prosperity.
The wrong kind of protection
In this month's brand new issue of the Fool's Rule Your Retirement newsletter, which is available 4 p.m. ET today, Foolish retirement expert and financial planner Robert Brokamp talks with special guest Allan Roth. As the author of the book How a Second Grader Beats Wall Street, Roth is painfully aware of the many tricks that financial services companies use to sell their products. All too often, not only do those products not achieve the goals that they seem designed to reach, but they also create major changes in the risk and reward profile of your entire portfolio -- and those changes can affect your potential returns for years into the future.
In his interview, one of the first things that Robert asked Roth was about equity index annuities. These products, which insurance companies including ING (NYSE: ING ) and American Equity Investment (NYSE: AEL ) offer, pay returns that are tied to the performance of a stock index like the S&P 500. With typical equity index annuities, you're guaranteed not to lose any of your principal even if the stock market goes down. But if the index rises, then you get a portion of that rise as your return.
The problem with equity index annuities, according to Roth, lies in the fine print of their prospectus materials. On one hand, because annuities are an insurance product, the insurance company has to make enough profit to pay an agent's commission while maintaining a fairly conservative investing strategy for its own corporate investment portfolio. As Roth notes, with their bond-heavy portfolios generating very little income these days, insurance companies have incentives to limit returns on the products they offer.
One way insurers do this is by defining terms in ways that wouldn't necessarily match up with how you'd initially understand them. The example Roth uses is a definition of "average return" that strips out dividends and gives you half or less of the index's actual appreciation -- all the while charging high fees. At the end of the day, you end up with more modest returns than you might have expected.
The right way to defend yourself
Recent experience bears out Roth's understanding of the annuity industry. In 2008 and 2009, insurance companies such as Hartford Financial (NYSE: HIG ) and Lincoln National (NYSE: LNC ) suffered big losses, in part due to the guarantees they had made on annuity products. Those companies ended up taking bailout money to shore up their finances. Peers like Manulife Financial (NYSE: MFC ) , MetLife (NYSE: MET ) , and Prudential (NYSE: PRU ) also saw significant losses that prompted many players within the industry to increase prices, decrease benefits, or even discontinue offering guaranteed variable annuity products entirely.
In the article in the new Rule Your Retirement issue, Robert discusses with Roth the fundamental issue of how to evaluate your investments. Using the right benchmarks, it's much easier to figure out if you're getting the returns you deserve for the risk you're taking. For instance, all too often, investors look at absolute returns when they should be looking at relative performance versus a benchmark index. Other times, people look at the wrong index, or fail to include dividends as a key component of total return.
For those seeking safe investments, Roth recommends a do-it-yourself annuity that beats the pants off insurance company products. You can see it along with the rest of the interview on our Rule Your Retirement website. It's a subscription service, but a 30-day free trial gets you full access to the article as well as everything else the service has to offer.
With the markets acting badly, it's more important than ever to earn the best returns you can. In the time it took you to read this article, you can learn everything you need to know to do just that.
Click on this link to start your free trial of Rule Your Retirement today.