I’m all for optimistic New Year’s resolutions that focus more on the good than the bad. But sometimes, addition by subtraction can be just as valuable, particularly when trying to improve your personal finances. In that spirit, here are seven investment products that most investors should resolve to move on from or avoid.
▪ Variable annuities for retirement income: Variable annuities combine the complexity of an investment product with an insurance wrapper, often layering high fees for both. The ongoing costs are large and exit fees are steep for the first several years. The only justifiable reason to own a variable annuity is if you have already contributed the maximum amount to your employer retirement plan, Traditional or Roth IRA, Health Savings Account and/or 529 college savings plan. If you still have extra income and are seeking tax deferral, then funding a VA might make sense. But choose a low-fee or flat-fee product without expensive retirement income guarantees.
▪ Nontraded Real Estate Investment Trusts (REITs): Private REITS are the king of the free dinner circuit. These products are illiquid, often with a 10-year lock up and tough-to-decipher fees. They are offered with enticing income and principal protection objectives. Some investors receive neither, depending on the experience with the underlying real estate owned by the trust. They are not transparent, don’t offer precise current account value and are often called out in the financial press for wrongdoing. There is a reason the North American Securities Administrators Association includes non-traded REITs on its list of Top Investor Threats.
▪ Structured notes: These products offer a better deal for the commissioned sales person or issuing company than they do to the investor dazed by their complexity. Structured notes are essentially an IOU from an investment bank that uses derivatives tied to performance of investment indexes. The chosen index usually needs to perform within a predefined range of returns for the product to pay off or protect principal. They require a heavy dose of financial engineering and are generally not something you would see sold by an adviser who accepts a fiduciary obligation to act in the clients’ best interest.
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▪ Small positions in individual bonds: I periodically see statements from brokerage firms that include individual bonds in small amounts, $900 here, $1,500 there. They may have been purchased at a discount from the broker’s internal supply and may produce an attractive return if held until maturity. But often these are long-term bonds with maturity more than a decade out. The problem arises when needing to sell. There aren’t many buyers for small bond positions on the open market (which in the bond world is not transparent anyway). Without an easily marketable holding, you may have to accept much less than the bond’s stated present value to sell.
▪ 403(b) accounts for teachers: Similar to the variable annuity example, these accounts should be funded only after you’ve maximized contributions to the state retirement account (TRS in Washington), an IRA, your spouse’s employer retirement plan, etc. In my experience, the 403b market for teachers typically offers investment choices that are more expensive and lower performing than similar 401(k) plans. Plus, service from 403(b) plan representatives frequently is nonexistent.
▪ Commodities: Historically, portfolio theory has shown some diversification benefit of owning commodities with a small portion of your investments because they do not behave like traditional stocks or bonds. But Thornburg Investments produces an annual study of real returns looking at what is left after inflation, taxes, and fees. In their study, through 2014, commodities produced negative real returns ver every time period from 1 to 30 years.
▪ Index funds with management fees more than 0.10 percent: Price competition among Vanguard, iShares and Schwab has driven down the cost of passive index investing to the benefit of the individual investor. Exchange-traded funds covering core elements of globally balanced asset allocation are available with miniscule ongoing costs aside from a small brokerage fee to purchase them. Shockingly, there are still billions of dollars invested in much higher fee funds representing the exact same investment. If your investing is mostly done in an employer retirement plan where you don’t have control over the investment choices, go to your plan administrator and ask for more low-fee fund choices.
If you stick to transparent products, low fees and liquid investments, chances are good that you will improve your financial future and not need to continue making resolutions to fix it.
Gary Brooks is a certified financial planner and the president of Brooks, Hughes & Jones, a registered investment adviser in Gig Harbor. Reach him at bhjadvisors.com.