We've had to interrupt our mutual fund research to bring in other items of current interest. A reader wrote in to ask if I thought their strategy to retire on was a good idea.

Of course, all facts and circumstances have been changed to protect confidentiality.

And it goes something like this. They are currently both 45 years old, married, three children, mortgage and both work full-time. They both work second part-time jobs because they want to pay off the debt from their home and children's university education as soon as possible. After that is over, in about ten years, they want to try and save enough money to retire at 60.

They plan to take both of their pensions as annuities, as well as purchase an additional annuity with half of the rest of their savings, leaving the last 50% liquid cash to grow in mutual funds.

They do not want to have a rental unit in their home. Is there anything wrong with this picture?

In theory, it does not sound like a bad idea, but not knowing enough about their total assets, the longevity of their family, their present and future job prospects, their savings patterns, their tolerance of capital market investments, their future dependent liabilities, and other related fact patterns, it is difficult for me to state unequivocally that this is the best course of action.

Sufficient to say is that every investment has some risk associated with it, so again sounding like a broken record, ‘they are indeed trying to hedge their bets, by not putting all eggs in one basket.”

Financial planners have been royally made fun of lately, on shows such as Squawk Box and CNBC for stating the egg theory, but it is so true. If your assets are truly diversified, your house may be destroyed but you will have some insurance and other savings and investments to fall back on. Conversely, your capital market investments may perform very poorly for a few years, but with a dry and debt-free roof over your head and a “guaranteed” annuity payment every month, you can still survive.

So, let us talk about annuities, and discuss the most common types, deferred and immediate annuities, either indexed or non-indexed, and either fixed or variable in definition.

All of these descriptions mean something very different in the final product.

I cannot stress enough that you fully understand the difference, because annuities are contracts, and once signed on the dotted line, cannot be changed. Never, I repeat, never sign for an annuity without researching all of your options completely.

An annuity is a contract between an insurance company and you under which for consideration - you pay them money - and the company agrees to provide you with a specific monthly payment for a number of years or for your natural life - and your spouse, if a joint annuity. How can they do that? In a deferred annuity, you pay premiums now over a number of years, the insurance company invests the money, and at a future retirement (or other age), you receive a series of monthly payments.

In an immediate annuity, you may be at the brink of retirement, you pass over usually a large portion of your accumulated savings (say $300,000) and immediately (the next month) you start receiving annuitised payments.

Simple. You know that ‘almost' no matter what, you will receive those payments month in, month out.

However, it is scary to think of parting with that amount of money because once you do, you lose control of that sum, generally forever. Fixed annuities provide a stream of money plus a return on that money for as long as you live. Investing your lumpsum payment is the responsibility of the insurance company; their payment to you is guaranteed, again for the life of the contract you sign.

If the market is bad, that is their problem; they have contracted to pay you no matter what. Fixed annuities may be paid against an index or not be indexed at all. The erosion of purchasing power in non-indexed payments in later years is very evident in adjacent chart, where we see that in 20 years a non-indexed annuity has had its purchasing power cut in half.

Variable annuity payments may be more or far, far less than the original amount you paid in. Guess who is responsible for the investments within the annuity? You are. Essentially, variable annuities are mutual funds within an insurance wrapper-type product.

Your contract may entitle you to a minimum payout, but most, if not all of the choices in what to invest in and how well the investments perform, lies on your shoulders. Know the difference, because if you don't you could end up with precious little monthly payments in retirement and not guaranteed at that. Guaranteed payments. Are they really? Two reasons to invest in fixed annuities is to minimise capital market risk and longevity risk (the risk that you will outlive your money).

But supposing, just supposing, you outlive the insurance company. What is the guarantee that the original insurance company will be around ten, 20, 30, 40 years from now, still paying that monthly stipend? As we all live far, far longer than mortality statistics predict, will that company still be there? In some cases yes, and some no. If it does not, you will still have your home and your market investments.

You need to research the financial strength and the capital reserves of the company you do business with, and keep an eye on it over the years.

A well run fiscally sound company that has steadfastly generated better than average credit ratings by industry overseers such as Moody's and AMBest, will in all likely not only survive, but thrive well into the end of the 21st century. We cannot predict the future, but we can hedge our bets by being diversified with investments we feel comfortable with.

And one more thing, the commission to the broker on an annuity is the highest in the industry, 6% front end load, as opposed to 3-5% loads for mutual funds. Remember well that an annuity may be part of your investment program, but it should not be all of it.

Staying involved in managing your finances will allow you to anticipate opportunities, and minimise risks while assuring you - but not guaranteeing you - of some financial success.

Martha Harris Myron CPA CFP(tm) is a Bermudian, a Certified Financial Planner(tm)(US license) practitioner and VP, Personal Financial Services, Bank of Bermuda. She holds a NASD Series 7 license, is a former US tax practitioner, and is the winner 2001-The Bermudian Magazine - Best of Bermuda Gold Award for Investment Advice. Confidential Email can be directed to marthamyronnorthrock.bm

The article expresses the opinion of the author alone, and not necessarily that of Bank of Bermuda. The author does not own or sell annuity products.Under no circumstances is this advice to be taken as a recommendation to buy or sell investment products or as a promotion for financial plans. The Editor of the Royal Gazette has final right of approval over headlines, content, and length/brevity of article.