Not surprisingly, some financial advisers are more inclined to exploit a client’s fear during a bear market than during a bull market. In periods of turmoil, such advisors encourage so called “safety net” investment vehicles.
The term “safety net” is used to describe an investment that promises the upside of a market with little or no risk. In some cases, guarantees such as a minimum income or principal protection are offered. Sometimes a bonus of at least 7% of the account value is also promised when an agreement is signed.
When an advisor pitches a safety net investment, it usually involves an insurance product, e.g. equity indexed annuity or variable annuity with living benefit guarantees. The downside of safety net investments is that while agent commissions are high, returns are low – averaging about 2% to 3% annually. Also, a surrender charge or exit fee of 6% is incurred if money is withdrawn within the first six to eight years. Finally, in many cases, the promised bonus is illusory.
In addition to being confusing, safety net features are also quite complex. Many investors sign a disclosure stating that they read and understood the 473-page safety net policy only to later express despair or shock at low returns or expensive exit options.
Money’s certified financial planner, The Mole, encourages investors to avoid safety nets altogether especially if they do not understand exactly how they work or will likely need to access money prior to the end of the vesting period.
“Give up the fantasy that you can get stock-market-like returns without taking the risk. You can’t,” The Mole advises.
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