August 15, 2011

By John Spitzer, Ph.D. and Todd Houge, Ph.D., CFA

For the long-term investor, even a modest level of unanticipated inflation can be devastating.  To illustrate the magnitude of the problem, consider an investor in the 32% tax bracket (combined Federal and State) who invests $10,000 for 10 years.  The security guarantees a 5% annual yield.  In 10 years, the investment will be worth $16,289 [$10,000 x (1+.05)¹⁰].  But if inflation is 3%, the investment will only be worth $12,121 in today’s dollars [$16,289 / (1+.03)¹⁰]  And, if the gains are subject to tax each year, the investor will only have $10,395 in today’s dollars [$10,000 x (1+.034)¹⁰ / (1+.03)¹⁰].  This amount is only $395 more than the original investment, representing an annual return of less than 0.4%!

As the illustrati...

May 4, 2011

By John Spitzer, Ph.D. and Todd Houge, Ph.D., CFA

Living Benefits Annuities have a feature that sounds too good to be true – invest in the securities market and receive a guaranteed minimum rate of return (typically 5% to 6%) or the market return, whichever is greater.  Wow!  No wonder these annuities are hot, especially for those who fear another market meltdown.

How do they work?  The annuity comprises two accounts, only one of which is guaranteed.  The “Account Balance” is the actual value of your investments (net of substantial fees) and has no guarantees.  The “Income Base” starts at the level of your initial investment and grows annually by a guaranteed fixed rate or that year’s return on the Account Balance, whichever is greater.

There is also a significant differen...

February 24, 2011

By John Spitzer, Ph.D. and Todd Houge, Ph.D., CFA

In a recent advice column**, two professional financial advisors addressed the following situation: An 83 year-old widow in OK health recently sold her home and moved into an apartment at a senior residence facility. Including proceeds from the sale, her savings total $500,000. Her monthly expenses are $3,500 of which $800 is covered by Social Security. How should she invest the $500,000?

Both advisors recommended that she hold 2-3 years of expenses or about $100,000 in a liquid account, despite low current yields, to provide for unforeseen circumstances. So the remaining $400,000 must generate $2,700 per month or $32,400 annually. Both advisors were in a quandary over how to achieve the required 8.1% annual return.

Money markets, Treasury ...