Earlier this summer, I wrote a column explaining why I believe annuities are terrible investments.
My colleague Alexander Green shares my disdain for these investments. And he’s been even more vocal than I have been about why investors should avoid these products.
But it seems, in lieu of the Great Recession, annuities are back in fashion. Last week, The New York Times published an article explaining how one type of annuity, the advanced life deferred annuity, can generate more income later in life if you put off receiving a payment right away.
Here’s the good news…
Annuities are sold on the notion of safety, and they guarantee your income. If the market goes down, you can’t lose money. It sounds nice.
But what the article did not cover is how expensive annuities are. Currently, the average annual fee is around 2.28%. That’s astronomical. And a lot of it has to do with the fact that annuity salespeople receive high commissions.
On top of this, your money is locked up and your gains are capped. (Many people don’t understand this last feature.)
For instance, even though the stock market is up 18% this year, with an annuity, your gains could be capped at 5%.
If you had taken out a variable annuity with 5% caps in 2009, you’d have missed out on over 129% gains during the past four years. Not to mention, if you haven’t noticed, Wall Street’s good years have always made up for its down years, and then some, to date.
Instead, I suggest you create your own annuity. It couldn’t be simpler, and it’s cheaper.
The D-I-Y Annuity
All you need to do is buy a basket of Perpetual Dividend Raisers. These are stocks that raise the dividend every single year. That way, the dividends you receive will increase each year. And it can be by a meaningful amount.
For example, the average dividend growth expectation of The Oxford Income Letter‘s Instant Income and Compound Income portfolios is 12%.
If my assumptions are correct, that means an investor who collects $10,000 in dividend income this year should collect $11,200 next year, $12,544 the following year and so on.
It should be calming to know there are hundreds of companies that have been raising the dividend for years. Some, such as Procter & Gamble (NYSE: PG), have done so since Eisenhower was president. Others, like Texas Instruments (Nasdaq: TXN), have a 10-year track record.
Additionally, you’ll get to participate in the considerable upside that stocks offer. Is there some risk? Of course, but over 10-year periods, stocks have gone up 91% of the time.
In fact, the only time stocks did not rise over 10 years was if an investor sold during the heart of the Great Depression or Great Recession. The average increase over those 10 years (including the losing years) was 128%. Does an annuity do that?
Furthermore, stocks that raise the dividend every year have never been down over 10-year periods, not including the Great Depression, for which the data was not available. But that does include the Great Recession. In fact, if you sold at the end of 2008, right near the bottom of the market, you still made 40%.
Stocks, particularly Perpetual Dividend Raisers, are not as risky as people think when you’re talking about the long term. If you have a 10-year or longer horizon, it’s riskier not to be in stocks as your money won’t grow and keep up with rising prices.
Here are four reasons why you’re better off creating your own “annuity”:
- It’s cheaper. When you create your own annuity with Perpetual Dividend Raisers, your costs are a few hundred bucks at the most, rather than thousands. All you do is buy stocks online with a $10 (or less) commission. That’s your only cost.
- You participate in the long-term gains of the stock market.
- You control your money. Your funds are not locked up. You are free to take it out without penalties (as long as you’re not younger than 59 1/2 years old if the money is in an IRA).
- And most importantly, your income should increase every year.
With some annuities, your income could increase if the market cooperates. With a portfolio of Perpetual Dividend Raisers, it doesn’t matter what the stock market is doing as long as the companies are raising the dividend. And remember, the dividend is not tied to the stock price.
Many companies raised the dividend in 2008 and 2009 despite sell-offs in their shares. If the companies are generating enough cash flow and have a track record of raising dividends, there’s a very good chance they’ll do so again.
When you create your own annuity, you maintain control of the money, receive an increase in income every year and more of the money gets invested rather than going to pay for the lease of the annuity salesman’s new Mercedes.