Why I tried to Sell An Annuity to Vanguard

Last Updated Oct 23, 2011 6:07 PM EDT

A couple of weeks ago, I was invited to Vanguard's headquarters to address their financial planners - nearly all Certified Financial Planners. They wanted me to speak about using behavioral finance in my practice. Naturally, the audience expected me to beat the drum on why indexing works and how I convince clients on the merits. Well, they certainly didn't get what they expected.

New age investing

I started out by stating the obvious to the planners, which was that I had always been a big believer in indexing and owning the entire market. But then I told them, admitting this would be a shocker, that I had recently rethought that approach. My change of heart was driven by how different things are now, by how much riskier the world has become. With sovereign nations going under, and even the US being downgraded, I experienced a conversion to "new age investing."

In such uncertain times, I explained, it was important for my clients to have their money available when they needed it - like to buy groceries. Stocks, even diversified index funds, couldn't do that. My money, I revealed, was now in a product that gave me:

  • Stock market upside with no downside risk.
  • The use of three market indexes, Dow, S&P 500, and NASDAQ, retroactively giving the best performer the highest weighting.
  • A seven percent bonus the minute I wrote out the check.
  • Liquidity with checkbook access.
  • Guaranteed income for life.

I told them how well it worked in good markets and how "zero was their hero" in down markets. This was clearly something no Vanguard portfolio could provide.

I concluded this part of the presentation noting that the seven percent bonus was only good until Friday and they should call me at 1-800-HONEST-Al if they wanted in on the action.

Why I lied to Vanguard

Though I'd love to say my acting skills were so good that the audience believed me up until the "Honest Al" part, I can't, I'm actually a lousy actor. Not to worry, Robert DeNiro, I won't be giving you any Oscar competition. But that's fine, because my point was to demonstrate how other planners were using behavioral finance to manipulate clients. And, in my view, no product ever invented uses behavioral finance more than the equity indexed annuity. In my make-believe pitch, I illustrated:

  • Greed -The upside of the market and the immediate 7% bonus.
  • Fear - The world is too risky now - you want your money to be there to buy groceries.
  • Regret bias - no more fear - zero is your hero.
  • Hindsight bias - retroactively selecting the weightings of the indexes.

I had to tell the planners how much more convincing I would have been if, as most of the planners selling this product genuinely believe, I felt like I was on a mission to help people.

And though I may not have been on a mission, the critical point I was trying to make with my dramatics was:  We can only use behavioral finance to educate rather than to manipulate.

Behavioral finance to educate

I use behavioral finance every day with my clients to help them understand why:

  • People will have urges to buy after the market surges and sell when it plunges.
  • People can't think randomly and will find patterns that are merely random.
  • Framing returns against the wrong benchmark (like the S&P 500 index) can lead to a costly illusion of beating the stock market.
  • We take mental shortcuts called heuristics that lead us to make simple, but very costly mistakes.
  • We want to sell our winners and keep our losers, when we should be doing the opposite.
  • Pain is a good sign we are investing well, and why feeling good is a danger sign.
  • Owning the entire market with the lowest cost index fund guarantees we will beat the vast majority of investors in that market.

Expenses and Emotions

Thanks to the broad index funds that Jack Bogle has brought to investors, it's easy to conquer expenses.  But conquering our emotions is a much more difficult task. It's just as easy to panic with a low cost stock index fund as with any other investment, and I've seen many people do just that.

There is no doubt that we must watch out for those using our emotions against us to transfer our wealth to them. On the other hand, I can certainly attest that I see my biggest enemy to successful investing every morning when I look in the mirror.

Author's note:  I have never sold any insurance product nor ever been licensed to do so. Also, the equity indexed annuity, after receiving much bad press for abuse, is now called a fixed indexed annuity by the insurance industry.

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    Allan S. Roth is the founder of Wealth Logic, an hourly based financial planning and investment advisory firm that advises clients with portfolios ranging from $10,000 to over $50 million. The author of How a Second Grader Beats Wall Street, Roth teaches investments and behavioral finance at the University of Denver and is a frequent speaker. He is required by law to note that his columns are not meant as specific investment advice, since any advice of that sort would need to take into account such things as each reader's willingness and need to take risk. His columns will specifically avoid the foolishness of predicting the next hot stock or what the stock market will do next month.