Guaranteed no loss? Not exactly
By Bob Moeller
WEAC Member Benefits
March 2005
Financial
Planning Seminars
Achieving
Financial Independence
Among the fastest-growing investment products today are
the “guaranteed no loss” investments connected to some stock
index. I’ve gotten dozens of e-mails asking about them. I generally
advise people to avoid them.
There are so many variations on these products that it
is difficult to make a specific analysis that will apply to most of
them, but there is no question that the guarantee you will not lose
money costs you a substantial amount. There are commissions, fees, and
typically huge withdrawal penalties if you pull your money out early.
But, you say, you intend to leave it in for the whole term, and there
is, after all, a guarantee you will not lose money (although sometimes
your guarantee is for the amount you invested less any commissions)
and you might gain if the market goes up.
Let’s look at one example. This is a brokerage product
offered by the Banc of America through its recently purchased brokerage
house, Quick & Reilly (now called Banc of America Investment Services,
Inc.) It is called “Minimum Return Equity Appreciation Growth
LinkEd Securities” or Index EAGLES. Here’s the deal:
- You invest your money for five years. Unlike an insurance company
product, you can only back out by selling your product on the open
market and no organized market is expected to exist, although the
shares will be listed on the American Exchange. You are warned that
you may lose money if you sell early.
- You are guaranteed that at the end of five years you will get back
at least all your money plus 5%. Not 5% per year, 5% total for the
five years.
- Your final value will either be #2 above, or the growth in the
Russell 2000 Index as calculated on a quarterly basis. It is important
to note that you do not get the amount of growth in the index over
five years, but the result of 20 different quarterly calculations.
- Each quarter, your investment may go up a maximum of 8% (if the
index goes up that much or more) or go down whatever the index goes
down. There is no limit to your downward movement. (Note: the 8% was
uncertain when I got the prospectus; it may have been changed to 9%.
Since all the examples used 8%, I will use 8%.).
Now let’s look at how this wonderful-sounding deal can be very
so-so in the real world. Let’s start with the index at 1000
just as an example. You invest $1,000.
- First quarter it goes up 10% to 1100. Your increase is limited
to 8%, so you have $1,080.
- Next quarter it goes down 20% to 880. You get the whole down
20% to $864.
- Next quarter it goes up 17% to 1030. You only get 8% to $933.
- Next quarter it goes up 7% to 1102. Your value goes up 7% to
$998.
You are exactly where you started.
The same type of up and down pattern for the next four years could
put the index up 50+% and you would get nothing but your 1% per year
guarantee.
Can you make out well? Sure, if the market acts in your favor. But
there is a good likelihood that you will not make out nearly as well
as the illustrations show. That no-loss guarantee costs you a lot, count
on it.
The key question is: “Since my upside is limited, is the downside
limited in terms of my final value before giving me my no-loss guarantee?”
Now, for the longer term 10-year type insurance company index annuities
with their high fees and penalties, there are some other things you
should remember:
- The stock market, as commonly measured in indexes like the S&P
500 or the Dow Jones Industrial Average, has never had a 10-year period
in which it ended lower than it started. At least not in the last
60 years. Putting it another way, you can pick any day you want between
1940 and 1994, and invest some money in the Dow Jones Average, and
10 years later you would have gotten back more than you put in. Why
pay a heavy price to guarantee you will not lose money over 10 years?
- Technically, you can create your own guaranteed no-loss deal just
by buying 10-year Zero Coupon Government Bonds which will mature at
the amount of your total investment in 10 years, and investing the
difference in the stock market. Example: Today a 10-year Zero Coupon
$10,000 bond costs about $6,750. Buying these guarantees you $10,000
at maturity in 10 years. You have $3,250 left to invest in a stock
index. You cannot lose money and you have a much better chance of
gaining, in my opinion.
Posted March 1, 2005
