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Author: libc Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75617  
Subject: Retirement Consideration Date: 2/23/2001 9:20 AM
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Frankly, the subject of constant average interest rate combined with a severe stock market decline, and the inability of having the proper software to make a realistic interest rate assumption for managing one's money during retirement...has convinced me that a "guaranteed lifetime income" through an annuity is not the worse-case scenario. Using an annuity to produce retirement income will make constant average return, compound return, etc. an unnecessary discussion.

In addition, although an annuity is not the ideal financial service vehicle to transfer wealth to your heirs, and its rate of return may be minimal when compared to the average return for common stocks, the peace of mind it provides by way of a monthly check in the mailbox or by direct deposit...may be worth the price.
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The Serious Flaw Regarding Constant Average Interest Rate!

"If we could be sure that our investments would earn the same return year after year, and that interest and inflation rates would remain stable into the future, financial planning would be easy. It would simply be a matter of accurately estimating our contributions to those investments over time, and our anticipated future cash needs to achieve our goals.

Unfortunately, for any given year in the future, we cannot accurately predict the return rate on investments, inflation rate, or interest rate. Yet, most financial plans assume a constant average rate of return, inflation rate and interest rate going forward. That's a very risky assumption, since these rates will certainly vary from year to year.

Consider the following simple example:

You have a $100 investment portfolio and your assumption is that you will earn an average of 10% per year on that portfolio. Earning 10% each year, your portfolio value would grow to $121 after two years. Given the market in recent years, a reasonable assumption, right? Not so fast! What if in Year 1 your portfolio earns -5% and in Year 2 it earns 25% (not unlikely given recent market volatility). In this case, your average return is still 10% over the two years, but your portfolio value grows to only $118.75. Given this simple yet graphic example, it's clear to see that by assuming an average rate of return on your investments over the full length of your financial plan, you could be creating unreasonably high expectations of achieving your goals."

Source: http://www.finportfolio.com
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However, in reality a value of $118.75 after two years is a 8.97 percent compound return not 10 percent compound.

P.S. The constant average interest rate methodology is most likely used on all non-term life insurance ledger statements, systematic withdrawal calculations, and mutual fund performance results. In my judgment a proper explanation of this system is essential.

LIBC
William D. Brownlie, CLU, ChFC, CIP, LIA

P.P.S. I look forward to your comments.

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Author: jrr7 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 28059 of 75617
Subject: Re: Retirement Consideration Date: 2/23/2001 10:24 AM
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P.P.S. I look forward to your comments.

While annuities may be right for some people, I strongly distrust someone with an "LIA" among their titles telling me of annuties' benefits. Particularly since that someone usually stands to benefit hugely if one of us purchases an annuity contract through him. I am *very* glad that you mentioned that (a) annuities don't transfer through to heirs, and (b) the return on annuities is lower than on other assets, because of the guarantee. [However, I know that if my mom dies the day after she retires, she's guaranteed to receive zilch from her annuity.]

Your post points out two important things:
1. that the "average annual returns" quoted by nearly all mutual funds are meaningless. The number that really should be promoted is the "compound annual growth rate", also known as the "total return, annualized". But even this number has NO influence on the mutual funds in the future.

2. That all the retirement calculators out there are suspect because they assume constant interest, inflation, and investment growth rates. I agree with you completely. Fortunately, there are retirement calculators that take these varying rates into account: www.financialengines.com is probably the best known; www.quicken.com has one also.

I don't think Mr. Brownlie is going to win many customers from the Fool site, because TMF is about learning for yourself and taking control of your investments. His implied suggestions in the previous post go against the grain of what is said on the fool: "Give up control, give up potential return, and pay higher fees."

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Author: libc Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 28061 of 75617
Subject: Re: Retirement Consideration Date: 2/23/2001 11:41 AM
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While annuities may be right for some people, I strongly distrust someone with an "LIA" among their titles telling me of annuties' benefits.

[LIA - Stands for Licensed Life Insurance Adviser, Commonwealth of Massachusetts, Department of Banking and Insurance.]

Particularly since that someone usually stands to benefit hugely if one of us purchases an annuity contract through him.

[Where in my post did you get the impression that I am selling annuties? I am talking about my own experiences at my current age of 68.]

I am *very* glad that you mentioned that (a) annuities don't transfer through to heirs, and (b) the return on annuities is lower than on other assets, because of the guarantee. [However, I know that if my mom dies the day after she retires, she's guaranteed to receive zilch from her annuity.]

[As stated in the post the purpose of the annuity is to guarantee a monthly income for life. When there is a spouse involved a guaranteed period should be elected. In addition, although not the ideal transfer vehicle they do transfer through to heirs if any of the guaranteed period remains.]

Your post points out two important things:
1. that the "average annual returns" quoted by nearly all mutual funds are meaningless. The number that really should be promoted is the "compound annual growth rate", also known as the "total return, annualized". But even this number has NO influence on the mutual funds in the future.

2. That all the retirement calculators out there are suspect because they assume constant interest, inflation, and investment growth rates. I agree with you completely. Fortunately, there are retirement calculators that take these varying rates into account: www.financialengines.com is probably the best known; www.quicken.com has one also.

I don't think Mr. Brownlie is going to win many customers from the Fool site, because TMF is about learning for yourself and taking control of your investments.

[Mr. Brownlie is not attempting to win any customers. I am retired. Again, to repeat myself I am simply sharing my current feeling at age 68. I am all for taking control of one's investments...but when one reaches their 70s they may not have the stomach for managing their own money.]

His implied suggestions in the previous post go against the grain of what is said on the fool: "Give up control, give up potential return, and pay higher fees."

[I believe that you are totally misquoting me. There is nothing in my post to warrant such a statement as you have made above.]

LIBC
William D. Brownlie, CLU, ChFC, CIP, LIA

This email advice is designed to provide accurate information in regard to the subject matter covered. It is performed with the understanding that William D. Brownlie is not engaged in rendering legal, accounting or other professional service including actively selling life, disability, long term health care insurance, and investment advice. If legal advice or other expert assistance is required, the services of a competent professional person should be sought.


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