Fidelity and Vanguard, monsters in the world of mutual funds, are busy creating new products catering to the vast number of baby-boomers approaching retirement. These products are designed to compete with annuities, insurance products with guaranteed income, but are investments products so they offer no guarantees. Like target retirement funds, the asset allocation of these funds of funds changes over time, but they are managed more actively.

Fidelity’s strategy is to create “Income Replacement Funds.” While target retirement funds are organized by the projected retirement date, the Income Replacement Funds are designed to liquidate in a particular year. There will be a fund for every other year between 2016 and 2042. Between the times of investment and liquidation, the fund will provide a monthly cash payment based on investment gains and possibly a portion of the principal.

On the other hand, Vanguard will be offering three different portfolios: Growth Focus, Distribution, and Growth and Distribution (a combination). The purpose of the Growth Focus portfolio is to maintain your principal while investing aggressively. The Distribution portfolio is designed to maximize your monthly payments while preserving the principal as much as possible. The Growth and Distribution portfolio falls somewhere in the middle of the other two.

In this way, with no end date, the Vanguard funds will operate more like a university endowment.

...[U]nlike annuities, these funds let you keep your money. After the $25,000 initial investment, you can buy additional shares or sell them without penalty, a big advantage if you need to pay for an unexpected expense.

The $25,000 investment sounds steep, but these funds are for retirees who may be changing their perspective at retirement. They will have the funds from their 401(k) and IRAs which will be tapped to help pay for expenses once retirement is in full swing.

I have not yet seen any information about projected fees to cover the operation and management of these funds.

Turning savings into income, Eugenia Levenson, Fortune Magazine, June 18, 2008.

Last year, a reader wrote into Consumerism Commentary with a story about how her elderly father was convinced to buy a variable annuity, locking away his money until after his likely passing. He had wanted to talk to a financial adviser, but found his way to Banc of America Investment Services.

Recently, Dateline took a look into Annuity University, seminars designed to teach brokers how to sell annuities to the elderly. Undercover, the Dateline producers infiltrated seminars and sales calls to show how the salesmen deceive would-be customers.

Dateline’s four-part special shows how these particular salesmen play down or intentionally ignore surrender fees, claim annuities are more liquid than CDs, and “puff up” their credentials by putting their photos on official-looking books and magazines and by creating recordings of fake radio shows.

Agents in these seminars are taught to treat the elderly like they are 12 years old and use scare tactics. They are instructed to tell clients that money is riskier in an FDIC-insured bank account than in an annuity product.

I firmly believe that any customer has the responsibility to research any financial product before purchase. Problems arise when seniors (or others) are trusting and when agents flat out lie. It’s difficult to make informed decisions if the information you receive is intentionally incorrect or misleading.

Not all annuity salesmen follow these tactics, of course. I would suggest being wary of any salesperson whose fiduciary interest is in their own commission from the sale. Not all annuity products are bad, either. Even Ben Stein is a big fan (with friends in the annuity business).

Please take the time to view the four-part Dateline presentation which uncovers the truth about Annuity University and some of its “graduates.”

Should you get a variable annuity when you retire? The company I work for hopes you will, but many financial advisers, gurus, and authors steer people away. The reason is simple—the benefits in the form of gains don’t outweigh the fees and diligent investors can manage their retirement money in the form of index mutual funds, at least with a long-term time horizon.

Ben Stein holds a differing opinion. He is a fan of variable annuities in moderation. He admits that only a portion of a portfolio should be invested in annuities in order to ensure a modicum of guaranteed income. Here are his reasons:

• Variable annuities allowed his parents, both economists but not great investors, to retire comfortably.
• Some annuities will “lock in” your stock market gains to guarantee you won’t lose your money. Of course, the stronger the guarantee, the higher the fee.

• Old people get Alzheimer’s. Even skillful investors can lose their ability to control their portfolios and can benefit from a regular check.

  Ben admits that individuals who are successful at investing and continue to be through retirement can manage to perform better investing on their own. He is thoroughly convinced that most people should consider putting at least a portion of their savings into annuity products when they retire.

  I’ve generally been strongly against variable annuity products, especially after hearing story after story of elderly people being encouraged to enroll their life savings into products from which they would be unlikely to receive a benefit worth the fees. I do see Ben Stein’s perspective and perhaps annuities would be worthwhile for some individuals in varying degrees.

  Why Ben Stein Loves Annuities [Money Magazine video]

Focusing on small spending habit changes is a good way to save significant money over the long term. No matter how many daily lattes you forgo, if you make poor spending decisions on major expenditures, all your ECRD savings could be negated in one moment. Consumer Reports has identified some of these major mistakes that, while common, could cost thousands of dollars unnecessarily. Earlier, I wrote about six such mistakes. Here are six more.

7. Maintaining an unhealthy lifestyle. Living healthy, including an acceptable body weight, low cholesterol, normal blood pressure, and no smoking, can reduce your expenses by $4,600 to $42,000 throughout your life. These savings come from reduced life insurance premiums for healthy individuals. Consumer Reports offers this advice:

Before you apply for life insurance, consult a doctor about the best ways to get your stats in line with the “preferred plus” underwriting requirements. Insurers are OK with you taking medications to achieve normal blood pressure and cholesterol levels.

I’m surprised Consumer Reports’ analysis stops at life insurance. There are many ways healthy individuals spend less than unhealthy. First of all, smoking is an expensive habit. Cigarettes are expensive and the health problems smokers will likely have to deal with will be financially difficult depending on the severity of the problem. Quitting smoking is one of the best things someone can do to save money, not just from the expensive cigarettes but from increasing health care costs. In general, unhealthy people visit the doctor more and perhaps require medication. While health insurance covers some expense, staying healthy is a much better choice.

Personally, I can do much better in this category by exercising and having at least annual check-ups with my doctor. I’ve tested my blood pressure recently, and that seems to be fine. I do not know where my cholesterol stands, and I could stand to lose a few pounds.

8. Ignoring Roth accounts. Roth IRAs and 401(k)s allow earners to set aside money for retirement while allowing that money to grow tax free. If withdrawn when allowed, and if the law does not change by then, earnings will be tax free as well. Roth accounts are excellent options for those who believe their tax rate now will be lower than their tax rate at retirement. I don’t think anyone’s guess is better than anyone else’s regarding future tax rates, so my approach is to diversify my tax exposure.

Consumer Reports estimates that ignoring the Roth option could cost $9,000 to $26,000.

9. Cashing out your 401(k). This figure surprises me. Consumer Reports mentions that 45% of workers cash out their 401(k) when they change jobs. I can only think of one situation in which this makes sense, and even then it’s sketchy. If someone finds himself out of a job unexpectedly after being fired or laid off, does not have any access to emergency funds, and cannot find a job immediately, I can understanding tapping into a 401(k). There are huge penalties for doing this, and I think it’s a bad option. Always be prepared for job loss by following these five suggestions, and you won’t have to worry about where your money will come from if you find yourself unemployed.

10. Underfunding your 401(k). One of the most common pieces of financial advice doles out by professionals is to maximize your 401(k) contributions to the IRS limit (after funding your emergency fund, meeting the requirements for your company’s matching contribution, and maximizing a Roth IRA). This is a somewhat difficult goal for many people. If you are single and earning $40,000 in New Jersey for example, and you have to pay for an apartment or a house, you’re going to find it difficult to pay all of your bills while diverting $15,500 to retirement. I only recenntly bumped my 401(k) contributions high enough to max out my 401(k), and I could only do so thanks to outside income.

Consumer Reports calculates that an average worker not contributing fully to a 401(k) would give up $36,000 in savings compared to one who does fully contribute.

11. Paying needless fund fees. Several years ago, when I first started investing, I set up a recurring purchase of a fund I had already owned through a UGMA account. I thought recurring purchases in AIVSX would help my portfolio grow. It turns out the fund did well when the market did well, but my purchase price did not seem to line up with the price of the fund on the purchase dates. The price I was buying the fund at was about 5% higher than the fund’s actual price. I later realized that I was paying a 5% premium each time I purchased the fund because it was a “load fund.” This load reduced my performance to below the market benchmark. Once I realized, I stopped purchasing the fund every two weeks. It was a waste of money and a lesson learned.

I could have easily found a no-load fund in which to invest. If I had continued with AIVSX, I might have wasted $4,000 over the course of my investment.

The high-cost fund that we chose had a 5.25 percent load and annual expenses totaling 0.45 percent. The low-cost fund was a no-load with annual costs of only 0.18 percent. The high-cost fund grew to $36,000, the low-cost one to $40,000. Note that we could have chosen a fund with even higher expenses, had we not done our comparison with index funds.

The magazine recommends Fidelity, T. Rowe Price, and Vanguard. I have accounts with Fidelity and Vanguard, and so far, I would have no problem recommending either of these companies. Both have low-cost, no-load index funds perfect for frugal investing.

12. Falling for a scam. Anyone can fall for a scam, even otherwise intelligent people. Professional con artists are good at what they do, and they continue to exist because the scams work often enough to make it worthwhile. Consumer Reports can’t even estimate how much someone could lose on a scam; it can be a family’s entire savings.

Always check out the license, reputation, and references of any company or individual you’re thinking of doing business with. Never respond to an unsolicited request for personal information, such as your Social Security number or online passwords, even if it appears to come from a business you know. Instead, call the company yourself. Be especially wary if you’re nearing or in retirement, a prime age group targeted by fraudsters because, as the bank robber Willie Sutton once said of his own favorite crime target, that’s where the money is.

On a smaller scale, sometimes gainfully employed professionals can commit what amounts to a scam. It pays to know all the details about any financial arrangement you agree to, whether it’s a car loan or a variable annuity. Many professionals are not required to act in their customers’ best interest, and what’s good for the salesman is not always good for the customer. If you are unsure, it’s best to wait before making a decision or bring someone knowledgeable and trusted with you. Last year, I wrote about an elderly person who was sold a variable annuity by Bank of America without really understanding the details. It’s likely she wouldn’t see any benefit from the product before she would pass away. It’s hard to always know who to blame, as there is often miscommunication, misunderstanding, and in some cases, misleading before the contract is signed.

12 money mistakes that could cost you $1,000,000 [Consumer Reports]