Insurance Q&A

June 1, 2012

Inflation Sedation

Filed under: Uncategorized — rrroark @ 12:30 pm

Remember when a can of soda cost a nickel? And candy bars were just a dime? Those days are long gone, as inflation over time has raised the price of just about everything. In the past, what your clients earned through wage gains or from their investments generally outpaced the rate of inflation. That difference, in the long term, has helped raise the overall standard of living of many people. Today’s inflation rates create a very different reality for your clients — one that is potentially quite frightening.

The most widely used measure of inflation is the Consumer Price Index (CPI). It is used to measure the changes in prices of all goods and services purchased for consumption by households. It is also an important measure of the overall health of the economy. Over the past 12 months, the Consumer Price Index (CPI) increased 2.9%, according to the Bureau of Labor Statistics. But does that paint the whole picture? Would you say the impact to your clients’ budget has been only 2.9% in the last year? Not likely.

The CPI number has, in the last few years, been suppressed by the lowering cost of some non-essential but useful items, like televisions and computers. The things we have to buy — life’s essentials — are skyrocketing. In the last 12 months, the price of beef is up 11.5%. Milk is up 9.2%. Gas? Up almost 10%. And the prices for college and health care have routinely outpaced that of general inflation for a decade or more.

Calculating inflation’s toll

A recent study by the American Institute for Economic Research developed the Everyday Price Index (EPI) to better reflect the day-to-day experiences of Americans. What they essentially did makes sense. They tweaked the calculation to scale back the percentage on some of the bigger categories with products that consumers can delay or avoid purchasing and focused on categories that are needed and purchased on a daily or weekly basis. A nice, new 50-inch HDTV or an iPhone is a luxury to many, while breakfast and dinner or the gas for the drive to work is not. With these revisions, the EPI for 2011 came in at a staggering 8% — well above the 2.9% increase indicated by the CPI.

In reality, those with additional mouths to feed or who have above-average commutes are likely experiencing even higher rates. CPI and EPI are just different attempts to capture a majority of the prices people are paying for an “average” basket of goods. What really matters, at the end of the day, for all individuals, is that their own income is keeping up with their own expenses.

So where does that leave your clients? In a financially scary place. Today’s inflation rates present a very serious challenge for those living on a fixed budget or in retirement. At the 8% EPI rate, the average American will lose half his purchasing power in just nine years. Even at the CPI rate of 2.9%, purchasing power would be halved in 25 years. But people in or near retirement could still have several decades of need for inflation-protected income. Making the situation worse, interest rates are still near record lows, and most bank savings accounts, money market and CDs are yielding less than 1%.

“Going broke safely” is a situation where investors have unknowingly kept money in low-yielding accounts or under the mattress. While it allows investors to sleep at night, inflation, over time, will erode the purchasing power of that safe money.

via Inflation Sedation.


Indexed Products: For the Best and Worst of Times | LifeHealthPro

Filed under: Indexed products — rrroark @ 12:26 pm

When you think about all the different obstacles consumers must face today on their way to a fruitful retirement, it boggles the mind. First, there are the endless choices with regard to financial products, from mutual funds to annuities (both fixed and variable), to individual securities like stocks and bonds, to bank products. The list goes on and on. And then there’s life insurance, from term and universal life, to indexed universal life and variable life, to whole life.

Fortunately, indexed products today are perhaps among the simplest solutions to help consumers cut through the endless clutter of product choices and ensure they minimize or eliminate uncertainty in their financial futures. Simply put, having indexed products as a core holding of an insurance and retirement portfolio can help ensure clients don’t find themselves in the wrong product at the wrong time. In addition, owning an indexed product as a core holding will help reduce the temptation consumers often have to do the wrong thing at the wrong time, even if for the right reasons.

Consumers: Their own worst enemy

DALBAR, an independent, Boston-based financial research firm, recently released its latest edition of the Quantitative Analysis of Investor Behavior (QAIB). Using monthly fund data supplied by the Investment Company Institute, QAIB calculates a proxy for investor returns and compares this number to the returns produced by the broad market as defined by the S&P 500.1

For the 20-year period from 1992 to 2011, the S&P 500 returned 7.81%, on average, per year. It should be noted that this number is significantly lower than in past years, reflecting a downtrend in long-term average returns for equities resulting from two deep bear markets, 2000-2002 and 2008-2009. For example, the average annual return for the 20-year period ending in 1999 was a whopping 18.01%. For the period ending in 2007, it was 11.81%.

Clearly, the most recent 20-year return is disappointing compared to past 20-year periods. Worse still, the average equity investor continues to do far worse than the market itself, and this underperformance is entirely due to poor market timing decisions.2 Simply put, rather than stand by the old maxim of “buy and hold,” most equity fund participants have darted in and out of their funds at the worst times. Fear and greed are the enemies of investing success, and they continue to prevail. Fear drives investors to sell when the markets are in a tailspin, and greed compels them to buy after market gains have already been booked.

Take, for example, that 20-year period ending in 1999, in which the market returned 18.01% per year on average. In stark contrast, the average equity fund investor earned far less, only 7.23% per year, during this time frame. Putting this into perspective, the average annual investor return during the best 20-year period of market performance still underperformed the average market return during the market’s worst 20-year performance, which happened to end in 2011.2

The reason for this poor outcome is simple — as Michael Jackson once said, “It’s the man in the mirror.” Individuals are their own biggest obstacle when it comes to successfully accumulating wealth over the long term, due to the powerful pull of fear and greed. People, more often than not, succumb to loss aversion, in which the pain from their losses is greater than the pleasure from their gains. As a result, they are quick to flee the discomfort caused by excessive market volatility, and, subsequently, they miss out on the big gains that always come without warning.

In contrast, they usually only want to get back into the markets once they’ve heard about the big gains that have already taken place. I mention “usually” because, this time, after a horrific decade of volatility and seemingly endless bad economic news, the markets seem to have quietly recovered, and yet, no one seems to notice or care. I suspect this is because they all think this may be yet another “head fake” designed to lure them in only to collapse and spit them back out, poorer for it once again.

As I write this, on March 18, the Dow Jones Industrial Average just crossed 13,000, the NASDAQ broke the 3,000 barrier for the first time since December 2000, and the S&P 500 Index crossed the 1,400 level for the first time since May 2008.

All of this happened during the week of March 12, exactly three and a half years since the financial crisis officially kicked off in September 2008.

Only three short years ago, in March 2009, these indices were hovering at roughly half of these current levels, as the global economy appeared on the verge of total collapse. Given the well-documented behavior of individuals reacting to financial volatility, it is fair to assume that not many went for broke in March 2009 to see their portfolios double in value by March 2012. Instead, like the rest of the world it seems, the bunker mentality was and is in full effect, leaving the equity markets to rise with little fanfare and the fixed income markets to continue rising while relentlessly pushing down yields.


via Indexed Products: For the Best and Worst of Times | LifeHealthPro.

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