There are three common questions I get as a Financial Advisor: How safe is this, how well might it perform and what is this going to cost. The cost question has become complex over the years as financial institutions find ways to make investment expenses more palatable.
One thing we all know by now is there is no free lunch. If an institution or Advisor provides a service, somebody is paying them, and it is probably you! So let’s figure out how, and how much the fee is and make a conscious decision as to whether or not it is acceptable.
I will start with TSP, since it is the one account most everybody reading this article has in common. Thrift Savings Plan fees are on the low end. Not much controversy here, but you do get what you pay for: No professional management, minimal fund choices, and limited withdrawal flexibility.
In a nutshell, TSP offers excellent returns when times are good and devastating losses when times are bad – unless you are hanging out in the “G” fund, but then you are not even keeping up with inflation. Where this gets interesting is when you have outside mutual funds, brokerage accounts or annuities…or if you are looking to transfer part of your TSP to one of these alternate investments after retiring or turning 59.5 and using your one-time tax free withdrawal.
Mutual funds have become very familiar and widely accepted and range from lower cost do it yourself families like Vanguard to more expensive versions perhaps coming with a financial advisor and corresponding full service sized commissions. Regardless of your choice, they all have management and marketing or 12b-1 fees and they are all spelled out in a prospectus.
The degree of full disclosure in a prospectus is impressive. But this has become the problem. These documents are now so large that they are often not even printed out and very few take the time to hunt for and dig out the various fees and add them all up. For those that do, a 2% sum doesn’t really sound all that bad. But actually, it’s a disaster!
First, it is not a one-time fee, it is an annual hit and the dollars removed are no longer there to compound. The results add up. If an investor saves $5,000 per year, earns 8% and pays a 2% fee, he amasses $786,000 over 40 years. But if he cut the fee to 1%, he winds up with $1,045,000. That is a $259,000 difference. That 1% didn’t sound like a big deal, but how about an extra quarter million dollars in your portfolio!
Back to my point about getting what you pay for at TSP. With these outside brokerage and mutual funds you will indeed be presented with far more investment choices, better accessibility and perhaps hands on professional advice. All this is an improvement over TSP, but perhaps not worth the cost. That professional advisor needs to make up the fee damage and out guess the market. Unfortunately, not many do.
What about annuities? Controversy central! This is mainly because there are several different types of annuities and even many financial columnists are confused as to the differences. The focus of this article is the impact of fees on an investment portfolio, so I will address only
“deferred” annuities here because they function similar to a regular investment account. They come in two main varieties: variable and fixed.
The variable annuity is essentially a mutual fund operated by an insurance company. They add some very innovative features that a traditional mutual fund cannot. Some of these features are quite good, but they are not free.
In fact, these features are very expensive. The variable annuity is an actual stock market investment and as such must be accompanied by a prospectus. I have one saved as a PDF on my computer that is 700 pages long. I won’t be printing it out! Depending on the features chosen, the fees range from 3 to 4% per year. Remember how much money just 1% cost in my mutual fund example?
What about the fixed annuities? Well, they have a whole different design to them with the biggest point being that they are not stock market investments at all. This is key to the fee structure.
Since your fixed annuity investment is not in a bucket of stocks managed by the insurance company, they get to keep your balance on their balance sheet. This means the insurance company can reinvest your money on their behalf and make a profit in that manner instead of charging you a fee. You heard that right…NO FEE.
Of course, you recall I opened this article with the cliche about no free lunch, so these fixed annuity companies need to have use of your money for a period of years before they are satisfied with their profit margin. But you are typically allowed to spend 10% of your balance every year without a fee. A fee only comes into play if you withdraw more than 10% annually or close the account within a specified number of years.
So contrary to popular opinion, if you truly want to avoid ALL fees, even the comparatively low TSP fees, a version of a fixed annuity is likely the lowest cost plan you will see, provided you are a long term investor. So what version of a fixed annuity is appropriate? The traditional fixed annuity is not a timely choice right now with interest rates so low, but the stock market linked “Indexed” annuities are very timely and very popular.
Simply put, if the market goes up you will lock in an interest credit, if the market goes down your balance stays at its previous high, and all the while, you keep 100% of your interest credits giving up nothing by way of sneaky and surprisingly devastating fees.
Our office specializes in the Federal employee benefit niche . We are licensed and experts in fixed indexed annuities in all 50 states. Please call to schedule a free benefit analysis and consultation on various plans with an emphasis on NO fees.
Todd Ensing, RICP® Retirement Income Certified Professional® 800-997-8434
This message is from Vince Bono
If you are intent on keeping your money in the TSP family of funds, this website might be of interest to you http://www.tspwatchdog.com They do not offer information on annuities or securities but do have a TSP monitoring alert system that is very effective.