I’ve really enjoyed the feedback from Financial Advisor readers on a couple of my recent columns, Three Strategies Overhyped To Consumers and Four More Strategies Overhyped To Consumers. It is nice to know I am not alone in my frustrations about some of these items and it is wonderful to receive suggestions of other strategies to include.

Before I get to the new additions to the list, I want to state once again that I do not think every item in these columns is universally worthless. In the right situation, some of these overhyped items will fit the bill. For the purpose of these columns, “overhyped” means the strategy is not likely to have a big impact, can’t or won’t be employed by many clients, or is likely to have a negative impact.

Reverse Mortgages

It seems nearly impossible to watch TV normally and not see an ad for a reverse mortgage.

To be sure, reverse mortgages today are much improved. There are a variety of structures and therefore a variety of potential uses but they make my list because there are few clients that are keen on the idea once they understand how reverse mortgages work. When clients are open to the idea, there are usually ways to address the problems reverse mortgages are touted to fix that are more palatable to clients.

Despite the vibe of some of the commercials, the crux of the issue is that a reverse mortgage is in fact a loan that must be repaid.

Payments do not have to be made and if the balance of the loan exceeds the value of the home when the property is sold, the borrower does not have to make up the difference. Both those features can be quite useful and make reverse mortgages very interesting.

The price for that payment flexibility is spending home equity at a faster rate than a lower interest alternative with servicing payments.

A number of studies show how tapping reverse mortgages can help maintain a retiree’s cash flow. I highly recommend Wade Pfau’s book, Reverse Mortgages: How to use Reverse Mortgages to Secure Your Retirement. It is the go-to resource on how various reverse mortgages can be utilized effectively.

Financial planners have a responsibility to present viable options and reverse mortgages deserve consideration but be prepared. When you bring up the topic of reverse mortgages, many clients are not going to react favorably. After a lifetime of working to have a paid-off home, they don’t want to borrow against their equity, especially at the higher costs reverse mortgages incur. Many will prefer looking at other ways to address whatever cash flow issue the reverse mortgage might help address. At least with our clientele, there is almost always an alternative to borrowing against the client’s home to address those issues.

Equity Index Annuities

The first factor that should curtail the use of equity indexed annuities (EIA) is the same factor that can limit employment of any type of annuity used for accumulation—taxes are only deferred, not avoided. 

Typically, clients already have a substantial pot of tax-deferred money through their IRAs and workplace retirement plans. For the most part this is a good thing because the client received a tax deduction for their contributions. Yet-to-be-taxed employer contributions and matches are great bonuses too.

For non-qualified accounts, plunking money in an annuity just creates another deferred tax bill for clients or their heirs through Income in Respect of a Decedent (IRD). They get no benefit up front.

When annuities are used in IRAs or other retirement accounts, the deferred taxes are the same as if they used other investments, but the client gets a layer of complexity and costs that to me are simply unnecessary. The guarantees that can be had in the annuity contracts are usually overpriced, sometimes abhorrently so.

Even lower cost annuities that have no surrender fees present additional hoops to jump through to place trades, move money into the contract, take money out of the contract to invest in things not available in the contract, or simply get funds to spend.

When EIAs first came out, the pitch was equity returns without downside risk. That was bunk. EIAs are not considered an investment in the securities markets and are regulated as a fixed product. These days fewer EIAs are aggressively touted as an equity substitute, though that pitch is still common.

Now, the pitch we see more often is that an EIA can be a great enhancement to the fixed income portion of a portfolio. I find the strategy underwhelming.

As a fixed product, by law, the insurer must be conservative with the funds. They basically buy bonds to meet the guaranteed rates and use the remainder, after accounting for the insurer’s costs and profit, to take positions in various derivatives tied to certain stock market indexes. The guaranteed interest payable, should the equity markets perform poorly, will be lower than what can be earned from conventional bond holdings. Further, to get above bond market returns, the equity markets need to rise.

Keep in mind too that common EIA structures apply credits to a value that the owner can’t actually get their hands on and is used to determine an annuitization payment. This value is higher than the amount they could walk away with. If annuitization is not in the cards, that untouchable number is irrelevant and the actual accessible cash value is what is important.

EIAs are tough to model because the insurer will change various factors like participation and cap rates as stock and bond markets conditions change. Fortunately, you don’t need a model to see flaws in the “EIA as bond substitute/enhancer” strategy.

Fortunately, there are newer, simpler and less costly varieties of EIA contracts offered to the fee-only community. Still, I’m still not sold.  The idea of using an EIA to improve fixed income returns seems a bit bipolar to me.

On one hand, the pitch is that clients should use EIAs because the market is too risky to go near, but on the other hand clients are told an EIA should give them better returns because the market is very likely to juice the returns. The stronger an agent suggests that better than bond returns will be the result, the stronger they are suggesting the equity markets aren’t so scary.

A much simpler approach is to build a good bond or bond fund portfolio and if you want to try to get a boost from stocks, invest a little in stocks. Twenty percent may even be high for a really conservative investor but nonetheless, a simple 20/80 ratio of the S&P500 and 5-year treasury bonds annually rebalanced has never lost money over a 5-year period (1926–present). Most EIAs want the money tied up longer than that. With lower capital gain rates and low cost ETFs and mutual funds, anyone can implement a similar strategy with far less complication, cost, restriction and taxation over the life of the investment.

Stop-Loss And Stop-Limit Orders To Protect From Losses

I often see stop-loss and stop-limit orders presented as ways to protect value when a client has doubts about the prospects for an equity holding. From what I’ve seen neither of these orders protect from losses all that well.

First thing I want to do is examine the effect of executing the simplest tactic for avoiding a loss—sell the stock. With a zero basis and applying the maximum federal long-term capital gain rate, selling a stock owned for more than a year means the client keeps 76.2% of the current value. If the basis is 50% of the value, 88.1% is left after the sale. It is a good practice to consider the compare outcomes to the scenario of simply selling the stock.

For loss limitations purposes, a stop order is always set at a price lower than the current market price. A stop-loss can fail as a loss limitation tool because hitting the stop price triggers a sale but does not guarantee the price at which the sale occurs. Once the stop price is breached, the order becomes a market order and the stock can sell at an even lower price. This happens often when stocks gap down at the open or due to breaking news intraday.

To combat this, you can place a “limit” on the stop-loss by which you will sell for no less than the limit price. The limit, however, does not guarantee a sale. Once the stop price is breached, if the market price is below the limit price, the sell order won’t be executed at all.

Regardless of whether the stop order executes or not, the result is often inferior to simply selling now. If the stock sells due to the stop, the client will always net less selling at the lower stop price. If no sale occurs, no loss limitation was achieved at all.

Dan Moisand, CFP, has been featured as one of America’s top independent financial advisors by Financial Planning, Financial Advisor, Investment Advisor, Investment News, Journal of Financial Planning, Accounting Today, Research, Wealth Manager, and Worth magazines. He practices in Melbourne, Fla.  You can reach him at [email protected].