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The Independent Adviser for Vanguard Investors
•
April 2016
•
13
FOR CUSTOMER SERVICE, PLEASE CALL
800-211-7641
other financial penalties on withdraw-
al, carefully balance out these factors
before locking up your money for an
extended period.”
Annuities are far from the invest-
ing remedy they are often made out to
be. All of that being said, there’s little
question that Vanguard’s annuity pro-
gram is one of the best in the industry.
As you’d expect with Vanguard, their
fees are among the lowest in the busi-
ness. And though limited in scope, the
program does give you access to some
top-notch managers. While many of
Vanguard’s annuity funds are clones or
near-clones of funds I talk about all the
time in this letter, here’s a brief review
to remind you of the various options.
Money Market Annuity
Unrated.
This fund is a clone of
Prime Money Market
. Once the
most popular annuity option,
Money
Market Annuity
has lost its cachet,
though I’m left scratching my head how
there is still over $1 billion invested
here. Yields on money markets of all
stripes have been pinned near zero
for years. As the chart above shows,
high expenses have swamped meager
yields, generating negative returns. Ask
yourself when (if ever) you last saw a
money market chart that went downhill
was! The fund’s last positive calendar
year was 2009.
With the Fed on pace to gradually
increase interest rates, there is light
at the end of the tunnel for holders of
this annuity. But my longstanding cau-
tion that parking money in any cash
account is not a good investment for the
future—particularly when your vehicle
is an annuity—still stands. Inflation and
the annuity’s higher expenses work to
erode your returns. Then taxes take the
final bite. A money market annuity can
be effective when you are transition-
ing cash into or out of an annuity. It’s a
money management tool, not an invest-
ment. I prefer the next fund for short-
term cash reserves.
Short-Term Investment-Grade
Annuity
Buy.
This is a clone of
Short-
Term Investment-Grade
. This annu-
ity option can serve as a place to put
money you expect to withdraw in a
couple of years, or as a buffer for mar-
ket volatility in a diversified portfolio
of annuities. It will definitely serve
you better than a money market. Yet,
while it’s a superior cash alternative
to Money Market Annuity, this is still
not a preferable pick if you are looking
to grow your wealth over the 10-plus
years needed to make annuity investing
even begin to be worthwhile.
Total Bond Market Annuity
Hold.
A clone of
Total BondMarket
Index
. The portfolio consists of a mix
of U.S. Treasury bonds, high-grade
corporate bonds and mortgage bonds.
With an intermediate-term maturity,
this bond fund has historically provided
investors with about 70% to 80% of
a long-term bond fund’s returns, with
only about half the risk. This is a good
choice if you are looking to create bal-
ance between stock and bonds in your
portfolio. In fact, holding your bond
investments in a variable annuity can
be an effective means of sheltering your
income and allowing it to compound
tax-deferred, while holding “growth”
investments in a taxable account. Of
course, the same caveats about higher
expenses in annuities still apply.
For years I have warned about
“total” bond market index funds and
their exposure to U.S. Treasury and
agency bonds—this fund is no excep-
tion. U.S. Treasury and agency bonds,
which are the highest-quality bonds,
are also the most sensitive to changes
in interest rates, and make up more
than 40% of this portfolio. The result is
that investors are increasingly taking on
interest-rate risk while being paid less
income. I suspect many investors here
are unaware of the perils.
High-Yield Bond Annuity
Buy.
A clone of
High-Yield
Corporate
, this portfolio’s ups and
downs have more closely tracked the
stock market than the bond market over
time. Companies that issue high-yield
bonds tend to be more dependent on the
economic cycle. When the economy is
weak, investors question the prospects
of these companies and their ability to
make good on their debts. But when the
economy is expanding, this portfolio
should benefit.
Investors saw this in spades last year
and early in 2016, as the falling price
of oil and struggling energy sector
weighed on high-yield bonds.
For all the risk that people associ-
ate with junk bonds, keep in mind that
High-Yield Bond Annuity
is less risky
than most. Most junk funds would
never buy the stuff in High-Yield Bond
Annuity—it’s too high-quality for
them. That higher level of quality keeps
returns muted when the economy is
steaming along, but will protect inves-
tors when the economy or the junk
market turns south.
For a deeper dive on high-yield
bonds, see the story
High Yield:
Opportunity or Trap?
on the front
page of last month’s newsletter. In
>
Matching and Mixing
Model Portfolio
Recommendation
Variable Annuity
Substitute
Capital Opportunity
Capital Growth
Dividend Growth
Diversified Value
Health Care
Cap. Growth (60%) +
Equ. Index (40%)
High-Yield Corporate High-Yield Bond
Intermed.-Term Inv.-Grade Total Bond
International Growth International
MidCap Index
MidCap
PRIMECAP Core
Capital Growth
S&P MidCap 400 ETF MidCap
S&P MidCap 400 Gro. ETF MidCap
Selected Value
Diversified Value
Short-Term Inv.-Grade Short-Term Inv.-Grade
Note: There are many imperfect matches between my favorite
Vanguard funds and the offerings in the annuity plan. That said,
this is a list of the options that are closest.
Money Market Annuity’s
Tumble
3/09
3/10
3/11
3/12
3/13
3/14
3/15
3/16
▼
Value
tops
out
8/14/09
$1.895
$1.897
$1.899
$1.901
$1.903
$1.905
$1.907
$1.909
$1.911
$1.913
$1.915
$1.917
▼
▼
▼
▼
▼
Value starts
falling 12/1/09
3-year return goes
negative 1/24/12
5-year return goes
negative 11/29/13
Value
bottoms
12/14/15
Value
stops falling
7/19/10, then
starts again
9/15/10