Fight Your Instincts: Investors Sign Up for Annuities at the Wrong Times

After last week's intense, if short-lived, stock-market crash, immediate fixed annuities might be looking good, especially to older investors. In fact, a new study finds that investors tend to base their annuity decisions on very recent market trends, making them more likely to annuitize during a market drop. But that approach can take a big toll on your retirement wealth.

With an annuity, an investor trades a large lump sum of money for a stream of monthly income for life. It's often a difficult decision for investors because the choice is irreversible. In an ideal world, a retiree would annuitize their savings when their portfolio has increased in value, because it gives them the opportunity to sell their stocks, collect the gains and exchange them for a larger monthly annuity payment.

But Alessandro Previtero, a finance professor at University of Western Ontario, found that investors do just the opposite: Frightened by market declines, they are more likely to annuitize when their portfolios have taken a hit. Meanwhile, when the market is rising, investors avoid annuitizing because they expect further gains.

In short, fear and greed rule the day. Just as investors make the mistake of selling their stocks when the market dives and buying -- or hanging on to them -- when it rallies, annuity buyers do the same thing. "If employees have additional resources invested in the stock market, positive returns can make them wealthier and less risk averse and, hence, decrease the value of choosing an annuity," Previtero writes.

What Bad Timing Could Lose You

Previtero investigated the relationship between the annuity decision and the stock market across several sets of data, including the actual pay-out decisions of more than 103,000 retirees between 2002 and 2008. They were enrolled in 112 different defined benefit plans at 63 companies. Some 49% of employees chose an annuity instead of a lump-sum payout.

To gauge investor expectations of the stock market during that period, Previtero used at a confidence index that measured the percentage of individual investors who anticipated a rise in the Dow Jones Industrial Average in the coming year. A 1-percentage-point increase in the index corresponded to a nearly 10-percentage-point drop in the probability of purchasing an annuity.

Previtero also looked at immediate-annuity-purchase data collected by LIMRA International from 1985 to 2009. After controlling for interest rates and business cycles, Previtero found that an increase of 1 percentage point in the average stock-market return decreases the total sales of fixed annuities by more than 5%.

"Recent stock-market returns can affect beliefs about future returns," Previtero writes. "After negative returns, employees might believe that this trend will continue in the future and, consequently, are more attracted to the annuity, essentially a fixed-income financial product. The opposite can happen after a positive trend in the market."

Previtero analyzed the outcomes for two theoretical employees: one considering an annuity before the credit crisis in December 2007 and the other making the same decision in December 2008. "Holding everything else equal, my estimates imply that the employee retiring in December 2008 is about 25 percentage points more likely to choose an annuity," he writes, translating into a 5% to 10% loss in that person's overall retirement assets.

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15 Comments

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petrisirak

The man says a drop of 5 to 10 %, in value, yet he does not take into account the overall drop of 20% in the market. So who is the winner, it is the annuity.

August 18 2011 at 7:43 AM Report abuse rate up rate down Reply
detkoncp

Only buy annuities with a good high fixed rate. Buy only when interest rates are high. The length till maturity depends on the age of a person. And buy them direct only.

August 16 2011 at 12:23 PM Report abuse +1 rate up rate down Reply
some1bo

That is because the crowd is wrong on turning points. The crowd cannot be right in financial markets when it is a zero sum game. There has to be more losers than winners by definition. This is why it is important to watch what the majority is doing, and decide whether it is time to do the opposite.

http://www.kondratieffwavecycle.com/stock-market/a-reliable-stock-market-indicator/

August 16 2011 at 2:06 AM Report abuse rate up rate down Reply
bpcoronel

This article just confuses more uneducated investors about annuities. Fact, an extremely small percentage of annuities are annuitized today. About 2%. Anyone making the decision of annuitizing without consulting their financial advisor (not an insurance salesman), or fully understanding themselves the consequences or timing of when annuitizing has no one to blame but themselves.

August 16 2011 at 1:16 AM Report abuse rate up rate down Reply
ebreit19

You have to look at all options in building retirement income. Annuities are a great way to add to your income. It need not be a huge amount of money returned, but enough that it adds a meaningful and consistent flow of money. It can even be possible to draw a greater amount of money ove a lifetime of retirement from the purchase than you may have paid into that annuity. I know because I'm experiencing that right now. Along with a diverse number of low risk sources of income and pensions, it may be possible to net a substantial amount of money over the course of, let's say, a 25 year period of retirement to maintain a life style you may envision. Simply said, all sources combined, no matter how small the return, are worth considering, especially if the return exceeds the amount of money initially invested. Good luck to all.

August 15 2011 at 10:14 PM Report abuse rate up rate down Reply
savemycountry911

Where does Fools Gold Mike weigh in on annuities?

August 15 2011 at 9:43 PM Report abuse rate up rate down Reply
ATM

The Japanese thought interest rates were too low also - until they realized, 20 years later, that rates stayed lowe forever, and they needed an income for life. Annuities are not great and are not bad. They are appropriate for certain situations and certain objectives.

These articles are hype and glorified sensationalism - but not journalism.

August 15 2011 at 9:29 PM Report abuse rate up rate down Reply
ATM

If annuities are so bad, why are they paying 200-300% higher than bank rates, and why are they also preserving capital for investors - plus they offer tax deferral. This writer needs an education on financial products - sounds like a typical young MBA out of school with no experience, spouting what Wall Street wants to be spouted.

As for me - I have seen annuities add value for clients for many years, as jourbalists and talking heads spoke against them.

My only concern is how insurance companies will preserveliving benefits with rates so low for such an extended period of time - their underwritiers did not forecast these low rates, and something has to give.

August 15 2011 at 9:27 PM Report abuse rate up rate down Reply
2 replies to ATM's comment
hgeorgech

whyare they paying highter rates? Answer: Ponzi scheme!

The newest guy is funding the saps who bought earlier ....

Try taking your $$ out of these (before maturity) - lotsa luck! Again, Ponzi !!

August 16 2011 at 3:13 PM Report abuse +1 rate up rate down Reply
2 replies to hgeorgech's comment
gaj638

OOPS wrong Hgeorge.....you are talking about Social Security...not annuities.

August 16 2011 at 3:58 PM Report abuse rate up rate down
nxston08

When you buy an annuity the insurance company pays the broker an average commision of 5% which comes out of the insurance company's pocket. A 100k annuity the insurance company is out of 5k paid to the broker. An annuity is a contract so of course you'll pay a heavy penalty if you renign on the contract. It's no different from any other contract. Break it and you'll pay. The insurance company needs time to invest the money in the market and make some for itself and you too. They can't do it if customers pull their money out whenever they feel like it. The insurance company will lose money which they ain't gonna do.

August 16 2011 at 5:49 PM Report abuse rate up rate down
nxston08

Right! Annuities have been around since the days of the Roman Empire. Longer than the stock market. This is how their generals got paid during retirement (along with the country villa and slave girls of course). Those who had annuities during the Great Depression made out fine. Billions of dollars are invested in annuities. That says something to the naysayers.

August 16 2011 at 5:56 PM Report abuse rate up rate down Reply
ATM

Funny- annuities preserved capital, and will preserve capitqal for new buyers as long as they hold until maturity -bond funds will lose pricipal when rates rise, and stocks- well they just lost what- about 17% in two weeks -

Whoever wrote this article needs an education from a retiree's perspective. Not a Wall Street puppet perspective - remember - Wall Street created the financial mess and bankrupted Iceland!

August 15 2011 at 9:25 PM Report abuse rate up rate down Reply
edwardbecka

place money regularly into an annuity. do not look at the ups and downs of the stock market. the stock market is not designed for little investors to make any money. if stocks go up or if they go down each trade benefits the brokerage and not the small investor. keep investing in the annuity. get your annual 4% and be happy. dramatic moves in the market can wipe out the small stock investor in a single day. trust the big insurance companies to make money and let them who know what they are doing jump in and out of the market

August 15 2011 at 6:34 PM Report abuse rate up rate down Reply