Outsource The Liability

By |2015-05-21T03:33:19+00:00October 13th, 2014|Annuities, Bonds|

By Bill Broich

It’s often said that hindsight is 20/20, but sometimes history can be the most experienced teacher. If we can learn from the past, we just might eb able to make decisions based on a more solid footing.

Everyone likes a good story but for me a horror story contains many more twists and turns than other genres. Here is an old horror story that is about to repeat, repeating in a very devastating way. We are now facing an economic situation similar to about 20 years ago, and I know from experience that you’re not going to like what’s about to happen to you and your important money.

Remember 1995 and bank products such as certificates of deposit (CDs) were paying a low interest, about 4%. People were sick of these low rates and every agent was looking for any alternative that made sense. Sound familiar so far?

Of course, today 4% would be a god send of a return, but remember, back even further when rates were sky high. In 1977, banks were charging 18% for a car loan and paying very high interest rates. Folks were used to getting 14% and 15% on US Treasuries (I bought $30,000 worth of Treasuries that paid a guaranteed 15%) and 8- 10% on tax-free municipal bonds, so by 1995, yields were in the toilet and our clients were disgruntled and sour.

Maybe you will remember that time; I do because I was just getting rolling in the annuity business. To take advantage of the situation of low interest, those wizards of Wall Street launched dozens of short-term bond funds. Some were marketed as a “CD Buster” and sales exploded, billions poured into the bond market. People loved them, and bought them. Many were sold with an assumed guarantee of principal, the money was safe and it was higher yield than the banks….Eureka!

I remember one case I was in competition with and a portfolio of short-term bonds with a 2 month maturity, AAA-rated paper, but the yield was targeted at 5.5 percent — a dramatic improvement over anything else in the marketplace.

I’m giving you all of this detail because I want you to imagine what it might have been like to compete with this type of fund. People put the majority of their available funds into these accounts, they were told by the stock market guys to commit their important money, and they did. How could they not? Everyone was doing it, and even if the horse stuff hit the fan, the extremely short-duration and high credit quality of the bonds would protect us. I mean, 2 months is pretty darn safe and short.

Many funds launched their funds amid much fanfare and excitement. It was the largest swing in money in years, it poured out of the banks and into short term bond funds. Imagine trying to compete with it selling a 10 year Great American Annuity….it was tough.

What happened next is why owning bond funds in an artificial high (or low, remember the Fed is using QE3 to keep rates low) interest rate is so dangerous. In June 1995, the Fed raised rates by 25 basis points, then a month later again. Suddenly, the bond market was not stable and concern was everywhere. In October 1995, the Fed raised rates for the 3rd time and the bottom fell out of the bond market, even short team rates were in free fall.

Folks who had invested at “par” were now facing a 30% loss in their principal (in less than 3 months). And a dramatic loss in yield, remember a bond portfolio manager must replace bonds at maturity with new offering, and the short term rate dropped like a rock over the edge of a cliff. Pandemonium pursued and people who had been sitting on the fence about making a decision about buying an annuity were now calling asking what our rate was.

I had a good friend working at Dean Witter call me and asked if I could provide product for his “better” clients, the ones who were screaming at him. Years later we laughed over a beer about how bad it had been. He even joked that he had to go to his car before dark so he would feel safe in the parking lot.

People who had bought the bond funds wanted out and guess what; they had lost a significant portion of their investment. Because Wall Street had invested these new products to take advantage of the market, they became sitting ducks for every attorney so licensed. Class action lawsuits became an every day affair and many broker dealers were forced to write checks, big checks to settle lawsuits.

So why am I telling you this story?

The Fed has been warning us for a couple of years now that they are going to raise rates. Everyone knows interest rate increases is coming. However, a sizeable number of stock brokers keep telling their clients (our target market) they’re safe in some kind of short-term, laddered bond portfolio. (really!) But they’re not safe. They’re going to get hurt badly and the funds might just be the important funds set aside for retirement.

If your money is important, money needed for some future event such as retirement, I recommend you consider one of our fabulous products, products that are guaranteed and safe. By doing so you are outsourcing the actual management of your funds to professionals who look at life long term, professionals who can sustain market fluctuations and are in it for the long haul. Outsource the liability, take the guarantees.

When rates do go up and the bond market dumps, your money will be safe and secure.

About the Author:

Bill Broich
Bill Broich is a well-known annuity expert with over 30 years of experience. He has written hundreds of articles on annuities and other financial topics, and has been a featured commentator on TV, Radio and the Internet. To follow Bill's profile, click here.