Creators of financial products like variable annuities, structured products, market-neutral, smart beta or principal protection funds etc. want you to think complexity is good for you. Sophistication gives you an edge over other ‘less-informed’ investors. But there is a price to pay for all that ‘sophistication’. Because my friends, with complexity comes confusion. With complexity comes steep costs. And with complexity comes dependence — on financial professionals that ‘can understand’ complex products and will handle your investments without you being a participant in the process.
Ask yourself this very simple question: who really benefits from all this complexity? I know I’m talking in generalities here, and not about any specific investment product or strategy. But if we ask the question and answer truthfully, the creator of complex financial products is usually the biggest beneficiary. So, does that mean that any financial product that has any level of sophistication is automatically lousy? Not necessarily. Complex investment products usually claim to have some kind of unique benefit, otherwise no one would ever buy them. The devil however, is often in the details.
Let’s consider the investment products I love to hate the most — variable annuities. I recently reviewed a variable annuity for one of my clients. The prospectus for the annuity (the document that describes how the product works) was 248 pages of very dense, small print text and charts. 248 pages! Has anyone ever actually read that whole thing?! I’m guessing the sales people themselves have never even read it! One of the things my client and I learned about this particular variable annuity is that the annual cost when you include all of the riders, asset based charges and fund costs is 3.45%! That’s three point four five percent! Every. Single. Year!
Variable annuities versus investing on your own
As competitive as financial markets are, there is no company or investment professional in the world that is able to confidently and consistently overcome 3.45% per year in fees and still compete with a low cost alternative. However the insurance company would tell you that the fees are reasonable and the benefits outweigh the costs.
In the case of a variable annuity, the benefit you are usually paying for is a lifetime income rider. For most annuities, this rider means that the insurance company will guarantee you a monthly payment even if the ‘current value’ of your annuity goes to zero. Sounds pretty good. The problem is that if you invest in a similar mix of investments (at a cost well below 3.45% per year and far easier to understand) you are usually better off until a break-even age that is either decades away or that is long past your life expectancy. In many cases, you can do far better for yourself by investing in similar, low cost and easy-to-understand investments.
So what should you do?
In my opinion, as an investor, you should understand what you own and how it works. Complexity is often justification to charge you high fees. The benefits of such complexity are often misrepresented and the costs often understated. Remember, anything that is worth owning is worth understanding.
If you don’t understand a product you currently own or one you are considering, I would be happy to meet with you and give you a no-cost second opinion.