In its February 2008 issue, Smart Money magazine noted that, while the options for investing beyond mutual funds may be more attractive than in the past, there are still choices that most investors should avoid. Four such products are:
Brokers and insurance companies tout the tax advantages of VAs, which grow tax free like IRAs. But distributions from VAs are taxed at ordinary income rates ? roughly double the capital gains taxes that would be owed if the assets were held in a taxable account. Once you add in payments for the underlying investments and insurance protection fees, a VA could cost an investor five times as much as an investment held in a taxable account. Put $20,000 in a low-cost annuity for 20 years, for example, and you could still have earned $15,000 less than if you had made the same investment in a taxable account.
Investing in rental real estate property sounds good ? you use the rent money to pay the mortgage and the property increases in value. But a hidden hazard to investing in real estate is that a small investor is never diversified enough. Most such investors tend to buy property near where they live, but if housing prices drop ? as they have been doing lately ? you are seriously overexposed.
On-line options trading at the broker E-trade has doubled in the past two years. Although Smart Money notes that options do have a place in sophisticated portfolios, they are not appropriate as a long-term investment for individuals.
Whole life insurance combines a death benefit with an investment account, which builds cash value over time. Whole life insurance’s problem, however, is that it is entirely too expensive. Commissions and sales charges of five to seven percent eat into the first year’s premium. As a result, it can take up to 20 years to see a return on all of the premiums paid. Smart Money urges investors to buy term insurance, the cheaper alternative, and then max out on retirement accounts.