Buy an Annuity Now? And How to Spot Financial Tricks Online

Ivanna Hampton:

Here’s what’s ahead on this week’s Investing Insights. Tesla could buy back billions of dollars’ worth of stock. Our analyst weighs in on the idea. Plus, the rising interest-rate environment is making some annuities more appealing. We’ll tell you what you should consider before buying. And sophisticated online tactics are tricking some people while they shop or invest. Morningstar Inc.’s director of financial psychology Sarah Newcomb explains what to watch out for.

This is Investing Insights.

Welcome to Investing Insights. I’m your host, Ivanna Hampton. Let’s get started with a look at the Morningstar headlines.

Tesla Holds Steady

Tesla was on autopilot in the third quarter reporting positive earnings while offering few surprises. The electric vehicle maker posted record revenue and deliveries along with also delivering volume growth and improved operating margin companywide. It comes as Tesla ramps up production at two new plants, one in Texas, and the other in Germany. It’s in line with Morningstar's view that increased production will increase the factories' profitability and lead to margin expansion. The company also revealed plans to spend up to 10-billion dollars on share repurchases next year.We view that as a good use of excess cash. We expect Tesla will eventually grow vehicle deliveries to over 5 million vehicles by 2031 while cutting production costs. We're maintaining our 250-dollar estimate of what we think the stock is worth. Currently, we view shares as slightly undervalued but recommend investors wait for the price to come down before buying.

AT&T Exceeds Expectations in Q3

AT&T’s third-quarter results exceeded Morningstar’s expectations. As a result, we believe the company is in a good spot to deliver steadily improving performance in the coming years. AT&T’s adjusted basis total revenue increased about three percent year over year. Wireless profitability remains solid and while the addition of new wireless customers slowed, revenue per customer spiked higher. The company continues to do a great job of bringing in new customers but isn't matching the pace of existing customers leaving. AT&T is also backing away from the 2023 free cash flow target of 20-billion-dollars set following the Warner spinoff. However, management expects growth in this area next year. Morningstar believes that’s reasonable and provides comfort around the dividend. We're maintaining our 25-dollar estimate of what we think the stock is worth and believe it to be significantly undervalued.

Snap Left Wall Street on Read

Snapchat’s parent company disappointed Wall Street in the third quarter, for the third quarter in a row. Snap missed consensus estimates. While daily average users expanded impressively, monetization was still a problem. Snapchat users’ behavior, macroeconomic uncertainty and Apple’s privacy policies are increasing advertisers’ hesitancy. While these changes may be hindering ad revenue growth for Meta and Alphabet, Morningstar believes it’s a lesser concern for these firms. We’ve lowered our near-term projections for Snap. However, we’re maintaining our 27-dollar estimate of what we think the stock’s worth, since we believe continuing user growth will bring in more advertisers. We applaud Snap’s capital allocation. The social media company announced a half-billion dollar share buyback given its progress toward generating free cash flow consistently. This investment requires patience.

Digital Deception

Sophisticated tactics online are tricking some people into buying things they don’t want, paying hidden fees, or sharing their personal data. A new report from the Federal Trade Commission reveals the digital deception is on the rise. Morningstar Inc’s director of financial psychology Sarah Newcomb has explored how this could affect investors.

Sarah, in behavioral finance, there are nudges and sludges. Can you define those for us?

Sarah Newcomb:

Yeah. So nudges are things that make doing what's in the best interest of the consumer easier. Sludges make doing what's in the best interest of the consumer harder. And what really matters here is whether or not the interests of the consumer and the vendor are aligned. Nudges generally make doing what is in the best interest of the consumer easier.

Hampton:

All right. How do we see nudges and sludges at work in our lives?

Newcomb:

Oh, they're everywhere, and they've been around since before behavioral science. We just now have words for them. So, marketing tactics have been pushing us, nudging us in this direction or that ever since there's been advertisement and sales. A lot of people will say, “Oh, well you're just talking about marketing.” But the thing is that, yes, though it is marketing, and most of the psychology behind nudges and sludges comes from marketing literature and consumer psychology literature—that's where most of the research is—but the reality is that as consumers, we need to be informed consumers, especially when it comes to financial products. A lot of people don't even think of financial products as products, but they are. They're products with different attributes, and they are appropriate for different situations at different times for different people. And if you don't know the appropriate product for you, you can easily be taken in on a product that isn't really designed for you, but will make someone else a whole lot of money.

And so we see things like this all the time from pop-up ads that are very hard to close, or subscriptions that are really easy to get into, very hard to get out of. Those are examples of sludge that I know everybody has encountered. It can be more complicated when it comes to financial products because financial products—often the structure of them is deep in paperwork that most people don't even read.

Hampton:

The FTC recently wrote about a rise in dark patterns, and these dark patterns tend to trick or manipulate people. You've recently written about this. What are dark patterns, and what are some that we should watch out for?

Newcomb:

Sludge is an example of a dark pattern. And in general, a dark pattern is a design feature that is intentionally engineered to make the vendor more money regardless of whether or not it's in the interest of the consumer. Generally we would say dark patterns are ones that run counter to the interest of the consumer. So an example of a dark pattern would be there are lots of video games out there where, in order to really get into real gameplay, you either have to buy a lot of different features for your character or you have to do what's called grinding, where you have to spend hours in the game just to get up to regular gameplay. And that is intentionally meant to get you hooked on the game, and it contributes to addiction patterns and to hours in the game that can really deteriorate a person's quality of life and mental health. And so dark patterns like that also appear in products and other services.

Hampton:

What do they look like in financial products?

Newcomb:

It really depends on the type of financial product. Predatory lending is one obvious example. But there are things that you might want to know about if you're in the market to borrow—things like equity stripping, where lenders will loan you up to the amount of equity that you have in a home, regardless of your ability to repay. And so that can put you into a debt trap without your knowledge if someone isn't there to help you understand what you really can afford, rather than what they are willing to lend you. Those two things don't always align. Loan flipping, where a lender sells a loan and then the customer is faced with paying fees, and those fees could be hidden in disclosures that are deep inside terms and conditions that don't tend to get read. So, predatory lending, also things like ballooning interest rates, or just really exorbitant interest rates that put people into a debt trap.

But there's also less nefarious things like misleading advertising, high-pressure sales tactics. Anytime there's an induced sense of urgency when there truly isn't a time restriction—those are patterns made to emotionally get you invested and fear missing out. Hidden and obscured fees and outright scams. All these things are out there, but the FTC’s report did a really good job of listing them, describing them. And then what I did in an article I recently wrote was I stripped out some of the major things from that report to make it a little bit easier to digest. There are many levels of this, depending on your interest level and your concern level, of how much you can learn about dark patterns and where to find them.

Hampton:

What should investors and shoppers do to protect themselves? What should they watch out for?

Newcomb:

I think the first thing that we have to do as investors is really understand that the investment world in the U.S. is regulated on the principle of caveat emptor, or buyer beware, which means that the onus is on us as consumers to understand whether or not a product is right for us. And the thing that makes sludges and dark patterns a little bit difficult to determine is that, depending on the customer, something could be a feature for one customer and a dark pattern for another. And it really depends on what your needs as a customer are and whether or not that product or service is truly appropriate for you reaching your goals. I think having objective data, objective advice, trustworthy advisors, and really just knowing people respond to incentives, and so, knowing where your incentives as a consumer may be in conflict with a vendor’s or a service person's incentives. It doesn't mean that that necessarily should be a deal-breaker, but you want to know about it. You want to be able to talk about it and look at those incentive structures and make sure that what you're buying is actually what you need.

Hampton:

Thanks Sarah, for breaking down this important topic for us. Listeners, watchers, we will put a link to Sarah's article in the show notes. Thanks again, Sarah.

Newcomb:

Thank you.

Hampton:

Thanks, Sarah, for breaking down this important topic.

The rising-interest rate environment has drawn attention to annuities. Some of the insurance products provide a guaranteed stream of income while others come with uncertain results. But what should you consider before buying? Here’s Morningstar’s Inc director of content Susan Dziubinski and Morningstar Inc.’s director of personal finance Christine Benz.

Susan Dziubinski:

Hi, I'm Susan Dziubinski with Morningstar. As yields have risen, some retirees may find that annuities are more compelling options for retirement income than they've been in a while. Is it the right time for you to consider an annuity? Joining me to discuss that topic is Christine Benz. Christine is Morningstar's director of personal finance and retirement planning. Thanks for being here, Christine, nice to see you.

Christine Benz:

Hi, Susan, great to see you.

Dziubinski:

So, let's start out with the basics. What is an annuity, and who might want one?

Benz:

There are so many different varieties of annuities that the term itself is almost useless, when I think about it. But at its most basic, an annuity is a contract with an individual and an insurance company, where you give the insurance company a portion of your portfolio and investment, and they send it back to you as a stream of income over some predetermined period or over your whole lifetime. So, from a practical standpoint, annuities have gotten a lot of attention, certainly in the academic community, a little less from actual people, but academics really like how elegantly annuities address people's need for lifetime income. Many of us have Social Security that we'll be bringing into retirement as a source of cash flows, lifetime cash flows. But beyond that, we don't have anything like that. Annuities are a way to augment those cash flows from Social Security, a way to supply consistent guaranteed lifetime income, which is something that you're not going to get from any investments that you might make in your portfolio.

Dziubinski:

Right. Christine, now we've entered a period of rising interest rates, which we haven't seen for a while. How are fixed annuities affected by rising rates?

Benz:

Well, positively. Payouts tend to get better during a period like the current one, in part, because when the insurance company takes in these funds from people purchasing annuities, they have to invest them somewhere in order to make the eventual payouts. And they have to, generally speaking, keep the money pretty safe. When higher yields come online, that translates into a higher payout that they're able to promise people who are purchasing the annuities. So, it's been a good effect for people who are in the market for annuities.

Dziubinski:

It's obviously a plus, but let's talk more in dollar terms. Can you give us an example of how this last round of interest rate increases affected annuity payouts?

Benz:

Yeah, I wish there were some historical receptacle of information about how annuity payouts have changed, but I did happen to have an example from just back earlier this year of what a 70-year-old who put $100,000 into an annuity would have had in terms of monthly income earlier in the year, in the first quarter. $100,000 for a 70-year-old would've bought $600 in monthly income earlier this year. It's up to $700 now, or $8,400 a year, so a meaningful increase.

Dziubinski:

Would all types of annuities benefit from these higher yields?

Benz:

It's a really good question, and the short answer is probably not. The pure income annuities would tend to be the most direct beneficiaries in an environment like this one, so a deferred annuity, an immediate annuity, any fixed annuity would tend to be a beneficiary. On the other hand, variable annuities, where the person who owns the annuity contract is directing the investment selections, where the funds could be invested in stocks or bonds. Those would tend to behave even negatively in a rising-yield environment, so they would not necessarily be beneficiaries of better yields coming online.

Dziubinski:

What are the caveats that come associated with annuities? What do people really need to understand and know before they would go ahead and buy?

Benz:

A lot. I always say, "Ask all your questions before you make an annuity purchase" because it's a big deal. You're entrusting the insurance company with your funds, so you'd need to check up on the financial health of the insurance company. That's really important. If they're going to be backing this product for many years into the future, you need to know that they're in good financial health. You also need to understand how inflation fits in. I would say that's the big knock on annuities is that you can purchase inflation protection on that stream of income, but it'll typically cost you to do so. So just understand the interplay with inflation. And the other key thing to keep in mind is, even though some of the income annuities that we've been talking about are very transparent and generally very low cost, the other annuity types, variable annuities, for example, can be very opaque and also very, very costly. So you really need to understand any costs that you're paying for additional features and bells and whistles.

Dziubinski:

Christine, thanks for your time. It's interesting that we are now in an environment where these products that we hadn't really spent a lot of time thinking about or talking about for retirees might actually come into play.

Benz:

Absolutely. Thank you, Susan.

Dziubinski:

I'm Susan Dziubinski. Thanks for tuning in.

Hampton:

Thanks Christine and Susan for the discussion about annuities. Thanks to podcast producer Jake Van-Kersen who puts this show together. I’m thanking you for listening to “Investing Insights.” I’m Ivanna Hampton, a senior multimedia editor at Morningstar. Take care.

Read about topics from this episode.

What Investors Should Know About Behavioral Tricks in Financial Products What Tesla Stock's 50% Decline Means for the Market Is AT&T Stock a Buy Ahead of Earnings? Snap Earnings Disappoint for Third Consecutive Quarter Your Guide to Annuities Understanding the 4 Key Annuities Types