In this episode of Enrich Your Future, Andrew and Larry Swedroe discuss Larry’s new book, Enrich Your Future: The Keys to Successful Investing. In this series, they discuss Chapter 23: Framing the Problem.

LEARNING: Understand how each indexed annuity feature works before buying one.

“I would never buy an annuity that didn’t give me full inflation protection.”

Larry Swedroe

In this episode of Enrich Your Future, Andrew and Larry Swedroe discuss Larry’s new book, Enrich Your Future: The Keys to Successful Investing. The book is a collection of stories that Larry has developed over 30 years as the head of financial and economic research at Buckingham Wealth Partners to help investors. You can learn more about Larry’s Worst Investment Ever story on Ep645: Beware of Idiosyncratic Risks.

Larry deeply understands the world of academic research and investing, especially risk. Today, Andrew and Larry discuss Chapter 23: Framing the Problem.

Chapter 23: Framing the Problem

In this chapter, Larry discusses how we, as human beings, are subject to biases and mistakes that we’re almost certainly not aware of. He introduces the concept of ‘framing’ in the context of behavioral finance, which refers to how a question or a problem is presented and how this presentation can influence our decision-making, often leading us to answer how the questioner wants us to.

Examples of framing

Larry shares the following examples from Jason Zweig’s book Your Money & Your Brain to support the theory of framing in decision-making. These examples illustrate how the same information, when presented in different ways, can lead to significantly different decisions, highlighting the impact of framing on our perceptions and choices.

• A group of people was told ground beef was “75% lean.” Another was told the same meat was “25% fat.” The “fat” group estimated the meat would be 31% lower in quality and taste 22% worse than the “lean” group estimated.
• Pregnant women are more willing to agree to amniocentesis if told they face a 20% chance of having a Down syndrome child than if told there is an 80% chance they will have a “normal” baby.
• A study asked more than 400 doctors whether they would prefer radiation or surgery if they became cancer patients themselves. Among the physicians who were informed that 10% would die from surgery, 50% said they would prefer radiation. Among those who were told that 90% would survive the surgery, only 16% chose radiation.

The evidence from the three examples shows that if a situation is framed from a negative viewpoint, people focus on that. On the other hand, if a problem is framed positively, the results are pretty different.

The indexed annuities fallacy

Larry Swedroe goes on to connect the concept of framing to investing, particularly in the context of indexed annuities. He explains how annuities are often presented with hidden costs and benefits, leading to misleading conclusions for investors.

According to Larry, indexed annuities are products that salesmen describe as providing “the best of both worlds”—the potential rewards of equity investing without the downside risks. Unfortunately, indexed annuities contain many negative features, making them an unfavorable investment option.

The SEC’s warning against indexed annuities

Larry points out that the typical indexed annuity is so intricate and filled with negative features that it is challenging for most investors to fully comprehend. He highlights a bulletin warning issued by the SEC in July 2020, urging people to be cautious about investing in indexed annuities, fostering a sense of careful consideration.

The bulletin advised investors to read the contract before buying an indexed annuity and, if the annuity is a security, to read the prospectus. Investors should understand how each feature works and what impact it and the other features may have on the annuity’s potential return. The SEC also suggested asking an insurance agent, broker, or other financial professional questions to understand how the annuity works.

The agency also reminded investors that indexed annuity contracts commonly allow the insurance company to periodically change some of these features, such as the rate cap. Such changes can affect your return. So, read your contract carefully to determine what changes the insurance company may make to your annuity.

So why do investors still love indexed annuities?

Despite the negatives, why do investors continue to be drawn to this product, purchasing tens of billions year after year? Larry offers a straightforward explanation. The insurance industry presents the investment decision in a way that directs investors’ attention to the potential for significant gains, the principal protection, and the guaranteed minimum return offered by annuities, instilling a sense of hope.

Further, all the products sold by the typical insurance company and Wall Street firms are laden with glitzy features. In each case, you’re paying an excessive fee to get that benefit, but they’re framing it, and you’re getting it without being told that the costs far exceed the mathematical odds of your getting it. This makes you lose sight of the costs and the lost upside potential. In other words, “you’ve been framed.”

Better alternatives to indexed annuities

Larry advises investors and financial advisors to frame problems in a way that allows for analysis from various perspectives. This is the best way to ensure investors consider all the pros and cons. He emphasizes that financial advisors can add value by understanding how human beings make mistakes and helping them avoid them, instilling a sense of responsibility.

He also discusses alternative ways to create a similar financial outcome to annuities, such as investing in Treasury Inflation-Protected Securities (TIPS).

Further reading

1. Jason Zweig, Your Money & Your Brain (Simon & Schuster 2007), pp. 134–5.

Did you miss out on the previous chapters? Check them out:

Part I: How Markets Work: How Security Prices are Determined and Why It’s So Difficult to Outperform

• Enrich Your Future 01: The Determinants of the Risk and Return of Stocks and Bonds
• Enrich Your Future 02: How Markets Set Prices
• Enrich Your Future 03: Persistence of Performance: Athletes Versus Investment Managers
• Enrich Your Future 04: Why Is Persistent Outperformance So Hard to Find?
• Enrich Your Future 05: Great Companies Do Not Make High-Return Investments
• Enrich Your Future 06: Market Efficiency and the Case of Pete Rose
• Enrich Your Future 07: The Value of Security Analysis
• Enrich Your Future 08: High Economic Growth Doesn’t Always Mean High Stock Market Return
• Enrich Your Future 09: The Fed Model and the Money Illusion

Part II: Strategic Portfolio Decisions

• Enrich Your Future 10: You Won’t Beat the Market Even the Best Funds Don’t
• Enrich Your Future 11: Long-Term Outperformance Is Not Always Evidence of Skill
• Enrich Your Future 12: When Confronted With a Loser’s Game Do Not Play
• Enrich Your Future 13: Past Performance Is Not a Predictor of Future Performance
• Enrich Your Future 14: Stocks Are Risky No Matter How Long the Horizon
• Enrich Your Future 15: Individual Stocks Are Riskier Than You Believe
• Enrich Your Future 16: The Estimated Return Is Not Inevitable
• Enrich Your Future 17: Take a Portfolio Approach to Your Investments
• Enrich Your Future 18: Build a Portfolio That Can Withstand the Black Swans
• Enrich Your Future 19: The Gold Illusion: Why Investing in Gold May Not Be Safe
• Enrich Your Future 20: Passive Investing Is the Key to Prudent Wealth Management

Part III: Behavioral Finance: We Have Met the Enemy and He Is Us

• Enrich Your Future 21: Think You Can Beat the Market? Think Again
• Enrich Your Future 22: Some Risks Are Not Worth Taking

About Larry Swedroe

Larry Swedroe was head of financial and economic research at Buckingham Wealth Partners. Since joining the firm in 1996, Larry has spent his time, talent, and energy educating investors on the benefits of evidence-based investing with an enthusiasm few can match.

Larry was among the first authors to publish a book that explained the science of investing in layman’s terms, “The Only Guide to a Winning Investment Strategy You’ll Ever Need.” He has authored or co-authored 18 books.

Larry’s dedication to helping others has made him a sought-after national speaker. He has made appearances on national television on various outlets.

Larry is a prolific writer, regularly contributing to multiple outlets, including AlphaArchitect, Advisor Perspectives, and Wealth Management.

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