Who Should Buy an Annuity?

On several occasions, I have gotten into a discussion with someone who is what I would consider a sophisticated investor. After all, someone who knows how to balance their risk, spread it out among a variety of investments, use calls and puts, stop loss and so on knows what they are doing, at least that has been my assumption. A portfolio should include a mix of stocks, bonds and international stocks. A book I am reading has 43 different portfolio mixes that include equities, real estate and good old fashioned cash. The goal is to keep up with the market and take advantage of the gains while avoiding the losses. One of the portfolios has 54% US stocks, 12% international stocks, 22% bonds with the remaining 12% in real estate, natural resources and cash. Of the US stocks, it is suggested you have 27% large-cap value, 12% large-cap growth, and so on. As the market shifts, you will want to rebalance your funds to manage your losses. Rebalancing. That means you have to know which of all that you need to sell, pay someone to sell it, then pay someone to buy something else. Where does the profit come in?

This assumes, in my opinion, that the markets move slowly enough to let me catch my breath, buy low, sell high and move on. That isn't how the market works. It is a very, very fast moving machine that doesn't care who gets in the way.

The big investors with billions and trillions of dollars in the market go a few steps further. Companies use huge banks of computers to constantly buy and sell stocks, owning something for only a fraction of a second. Stocks are sold in lots far larger than any ordinary investor such as myself, would ever be able to manage. Buys and sells are based on complicated algorithms that watch every stock for any sort of movement with no regard to poor management, poor returns or much of anything human-based. The computer just watches when a stock shifts one way or another and makes a move toward it. You may recall a few years ago when there was a very large drop in the market that returned a few minutes later all due to someone making a mistake with a computer.

Large numbers have an advantage over small. If I have $1,000 of stock and it earns 1%, I now have $1,010. If I have a billion dollars of that same stock, I now have $10 million. That is power. My little thousand, or hundred thousand, or even a million dollars has no effect on the market. Thus, as an investor I am completely dependent on the actions of fast moving humming computers which don't care an ounce about me. The days of people yelling and screaming on the stock market floor are gone. The analogy I see is myself standing on the freeway in the center divide with my car, trying to get across to safety. I might do it, but my chances are very small.

What is the purpose of an investment? To make my money grow. Savings protects my money but investing makes it bigger. Why do I want my money to grow? Because the cost of everything around me is constantly growing and I need to keep up. Investments with guaranteed returns such as annuities and life insurance are the foundation of my security. Putting my future entirely in the market is just a gamble and one that I will surely lose. Once I have protected my future than I am ready to buy that high tech stock or start my string of rental homes. Before that is done, take care of business. Get a plan and stick to it.

If I want my money to grow, I also want to have a tax advantage. I showed earlier that if I have $1 and let it double every year for 20 years without taxes, I would have over $1mil. But if I had to pay taxes of, say, 35%, each year as it grew, I would only have around $26,000. I mention this here because when I buy and sell stocks, I have to keep paying taxes on my gains.

Another thing I get tired of hearing is that this fund or that has an "average return" of some X%. The trouble with that is the average is not the actual return. Thus growing one year by 50% and losing 50% the next has an average return of 0. If I have $100 and it grows to $150 the first year, the next year I lose half, $75, leaving me with an actual return of -25%.
The insurance products guarantee that I will never lose money. Guarantees cost money, but never as much as the result of the guarantee.

Thus in my humble opinion, no matter how much money I have, I would not be wise to depend on market fluctuations for my future. I want some guarantees and then I will spin the roulette wheel for luck.

Am I an unsophisticated investor if I want to be sure that my financial foundation is strong? I don't think so.  Who should buy an annuity?  Anyone who is going to depend on their savings for their retirement.  I am one of those people.