Investing's 6th sense: The B.S. detector

NEW YORK (Money) -- Question: A talk radio station I listen to runs an ad for an advisory firm that claims to be "safe money advisers, not Wall Street brokers." The ad promises that if you roll over money into an account at their firm, they will immediately match 10 percent, so that if you invest $100,000, you'll actually have $110,000 working for you. There are other ads on the program that say you can earn high returns but your account value won't go down if stocks do. Have you heard about these types of investments? What are they and how do they work?- Alex Klebern, Northfield, Illinois

Answer: Over the years, I've developed pretty good instincts for sniffing out investment baloney of all sorts. I call this sixth sense my "BS Detector."

Whenever I hear claims that sound specious in some way - too good to be true, likely to come with miles of string or bloated fees attached - my BS Detector sets off a little alarm in my head: "Ahhoooga, ahhoooga! You are the target of a dubious sales pitch. Hold onto your money with both hands!"

That alarm began blaring as soon as I began reading your question. Of course, it's hard to say exactly what type of investment this firm is peddling without having something more specific to go on - a prospectus, a contract or even a sales brochure (although sales and marketing brochures don't always offer much in the way of specifics). But my instincts tell me that this firm is probably hawking annuities of some type.

Indeed, based on the way you've described the ad, my guess is that these advisers are touting two types of annuities.

The first is probably a "bonus" annuity. You invest a specific amount, and the insurer agrees to automatically credit your account with a bonus usually equal to 6 percent to 10 percent of your initial investment. The second type sounds like an equity indexed annuity. This type of annuity works much like a hybrid of a bank CD and a mutual fund.

Typically, the return is tied to the performance of a benchmark like the Standard & Poor's 500, although you also get a guarantee that your account won't lose money or that you will earn some minimum rate of return on some portion of your account, usually 2 percent to 3 percent a year.

While both these investments have an elemental appeal - who doesn't like free money or the possibility of a big upside with no downside - they also come with some major hitches.

Let's take the bonus annuity first. I think we can all agree that insurance companies - which are the issuers of annuities even if they're sold by someone else - don't have free money to throw around. Which means if they're giving you a bonus with one hand, they've got to be getting something from you with the other.

One way they effectively get back some of the bonus is by charging you a higher level of fees. If the bonus is part of a variable annuity, you can check out the fees by reading the prospectus, although I warn you it can be tough sledding to make sense of the various layers of charges (the M&E fee, administrative fees, rider fees, subaccount charges, not to mention waivers that sometimes temporarily reduce these charges).

In other cases, insurers may restrict access to your bonus. You may have to keep the money in the account for long time, or you may have to "annuitize" to get it - that is, take your account's value in monthly payments instead of a lump sum.

That may not be so bad if you're looking to guarantee monthly income in retirement. But the rub is that the "annuitization rate" you receive - that is, the size of the monthly payments given the value of your account - may be much lower than what you could get by going to another insurer with the same amount of money.

In other words, you're paying for the bonus by getting smaller monthly payments. With equity index annuities, the hitch usually comes in two ways.

First, your upside potential depends on how the gains in the index that the annuity tracks are calculated. Some give you only a portion of the index's overall gain or set an annual cap, and most exclude dividends. There are dozens of variations, some mind-numbingly complex.

And then there are the surrender charges. In some index annuities, these can go as high as 20 percent and last 15 or more years. So you may not have access to all of your money without paying steep penalty charges for many years. (For more on how equity indexed annuities work, click here and here).

Add up the fees, the restrictions and the complexity of these products and I think you end up with an inferior investment. Overall, I think you're much better off creating a diversified portfolio, keeping the portion of your money you need to be really secure in bond funds and money market funds (or CDs) and the portion you can afford to invest for long-term growth in stock funds. This approach can give you sufficient security without siphoning off big fees and tying up your money with myriad restrictions.

I should add, by the way, that just because I don't like these types of annuities doesn't mean I'm "anti-annuity." I believe annuities can be an excellent way to provide guaranteed income in retirement to people who need it, although the type of annuity I think does that best is a plain old "immediate annuity." (For more on how this type of annuity works and how it might play a role in retirement, click here.)

Of course, just like the traveling medicine show salesmen of old touted miracle elixirs, there are always going to be investment advisers (and I use that term loosely) today and in the future who claim to have some marvelous investment that does amazing things.

When you hear their spiel, I hope it triggers an alarm in your head as it does in mine:" Ahhoooga, ahhoooga! You are the target of a dubious sales pitch. Hold onto your money with both hands!. And I hope you don't sign anything unless you've read all the fine print at least twice - and understand it.