by Archie M. Richards, Jr., CFP^®
January 13, 2003

Brent writes, "Because of my concerns about war and terrorism, I'm thinking of pulling $400,000 out of stocks and buying a fixed annuity that would pay $2,500 a month to my beneficiaries for 20 years and to me for life. I'm 68. I don't need the income now, but I want to hedge my portfolio. What do you think?"

Since World War II, Brent, America has suffered a scary cold war, three pretty big hot wars, and miserable economic policies that drove inflation and interest rates sky high. Yet during the entire 56 years, the S&P 500 rose something like 12 percent a year.

And you want to pull out of stocks because of a piddling little conflict whose ground fighting will probably last only a couple of days? Come on! The more worried investors become about a problem, the faster the market rises. It rises before the problem is solved, in anticipation of the solution.

As to terrorists, I expect those denizens of darkness to have their heads turned sooner than people think - probably within a year or two.

As you know, the annuity income comes first to you. If you die within 20 years, the income continues to your beneficiaries for the balance of the 20 years. Here's how to understand the rate of return: Let's say you deposit $400,000 in a bank account and withdraw $2,500 a month. At the end of 20 years, the account balance is zero. To make this possible, the account would have to earn 4.4 percent per year.

But let's say you survive your 88th year. The beneficiaries would receive nothing, but the $2,500-a-month income would continue to you for as long as you live. Should you die at 98, the return would be 6.4 percent per year for the entire 30 years. If you're still kicking at 108, the annual return for 40 years would be 7.0 percent.

In contrast, I expect stocks to return at least 12% per year and probably more during the next ten years. Over time, I expect the dismantling of the gargantuan government sector that began building at the time of Teddy Roosevelt. This will drive stock prices much higher. The dismantling will take place faster after the number of Senate liberals falls below 40 and they can't fillibuster. The greatest beneficiaries will be the poor.

We face the golden age of American civilization. Technology and free markets will perform incredible wonders for mankind all over the world. Only later in the century, when so much of the work is performed by robots, may Americans get soft.

The tax laws favor your continuing to hold the stocks. Say you die while still holding them. Their cost for tax purposes would "step up" to the values as of the date of death. Whoever sells them thereafter would pay little or no capital gains taxes.

But if you liquidate your stocks now, you'll pay capital gains right off. Furthermore, whoever receives the annuity income would pay ordinary income tax at high rates on a portion of the income. If you switch to an annuity, you'll pay more taxes - and you'll pay them sooner.

At least consider cutting the amount you invest in an annuity from $400,000 to $200,000. Ameritas Direct (800-552-3553) offers a no-load annuity that would give you a better deal than the policies of most insurance companies.

Marvin writes that, for $1.6 million, he can buy a small but attractive house in a "great" neighborhood of Palo Alto, California. Should he buy it on the theory that in the long run, homes always rise in value?

Not just on that theory, Marvin. If Governor Davis ruins California's economy even more than he already has, no one will want to live there and the prices of homes will fall.

I expect the nation to enter a long period of generally declining prices amid prosperity. If this occurs, California real estate would probably stay level and possibly fall.

Choose a home because it satisfies your emotional needs, not your investment needs. For a real estate investment, use an index fund of real estate investment trusts.