Back in 2020, I bought a 5-year deferred fixed annuity, also known as a Multi-Year Guaranteed Annuity (MYGA). A MYGA, in essence, is like a CD issued by an insurance company. The insurance company guarantees a fixed rate for a fixed period. I spoke about MYGAs in my April 2021 presentation, Fixed Income Alternatives in a Low-Yield Environment.
I bought the 5-year MYGA because it was paying significantly more than a 5-year CD from a bank or credit union at that time. The MYGA paid 3% a year. The best 5-year CD was paying 1.5%. This MYGA had reached its 5-year guarantee period last month. I ended it and pulled the money back to my Fidelity account.
The insurance company kept all its promises. Everything worked exactly as advertised. The MYGA was illiquid, with a prohibitive penalty if you withdraw more than 10% of the balance each year, but I knew that going in. The insurance company was a little slow in processing paperwork, but it was nothing compared to the slow manual processing at TreausryDirect, which can take from six weeks to ten months.
In terms of investment returns, the MYGA did better in these five years than a short-term bond fund, a total bond market fund, a 5-year Treasury, and the best 5-year CD. It trailed a 5-year TIPS by only a hair. I Bonds did better, but they had low purchase limits.
However, I would put my experience with MYGA in the “winning the battle but losing the war” category. That’s why I’m not renewing it or buying another MYGA.
The war is against inflation. Inflation averaged 4.5% a year in the last five years. Because you pay taxes on the gross return, if your tax rate is 25%, you’d have to earn 6% a year to keep pace with inflation. Viewed through this lens, all bond investments lost to inflation in the last five years. The Vanguard Total Bond Market Index Fund had a negative 5-year return before inflation.
Bond Substitutes
Burton Malkiel is the author of the famous book A Random Walk Down Wall Street. He was making rounds in the podcast circle in the summer of 2020 to promote the 12th edition of that book. Mr. Malkiel called the low-interest-rate environment at that time “financial repression.” He suggested lowering the allocation to bonds and investing in preferred stocks and high-dividend stocks as “bond substitutes.”
Burton Malkiel’s suggestion for investing in “bond substitutes” was controversial at that time. Some commentators went so far as to say it was stupid. Now we see the results after five years.
Preferred stocks didn’t do well, but high-dividend stocks did. Investing 50:50 in preferred stocks and high-dividend stocks outpaced inflation both before tax and after tax. Bond substitutes won the war.
The Forest and The Trees
My excursion to MYGA shows that we tend to pay more attention to things that can be analyzed with greater certainty, while neglecting things that are more uncertain but have a more significant impact. I often see people asking questions along these lines:
Which money market fund should I use?
Buy I Bonds in April or May?
Should I invest in Fidelity’s S&P 500 fund (FXAIX) or Vanguard’s S&P 500 ETF (VOO). What about Fidelity’s Zero fund?
TIPS ladder or TIPS fund?
Each question is complicated in its own way if you look at it under a microscope. There’s a powerful spreadsheet that sends you an email alert when it’s time to switch from one money market fund to another. These decisions make a difference, but they easily fall into the “winning the battle but losing the war” category. Before diving into the best place to park your cash, consider whether you should park that much cash in the first place. Then you will avoid a dilemma like this:
Saved up 1 million for a house we are no longer buying, now investing it into the market
The big-picture decisions don’t have an easy answer, but they make a much larger difference when you get them right.
How much to invest in stocks, bonds, cash, real estate, Bitcoin, or gold?
U.S stocks versus international?
Value stocks or growth stocks?
Developed international countries or emerging markets?
Burton Malkiel got the “bond substitutes” right. However, his other suggestions in the same podcast episode for increasing allocation to international stocks and increasing allocation to emerging market stocks within international stocks didn’t pan out. His arguments sounded convincing, and they still do today, but the markets just didn’t accept them.
U.S. stocks outperformed international stocks, and developed market stocks outperformed emerging market stocks, both by a substantial margin. How much you invested in US stocks versus international stocks, and in developed international countries versus emerging markets, made a huge difference in the last five years. This is why VTSAX-and-chill was an easy sell.
Maybe it will take more time for those other suggestions from Burton Malkiel to have the last laugh. Maybe they won’t ever catch up. Either way, don’t lose sight of the forest when you examine the trees.
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