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Create Your Own Pseudo Annuity

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Yesterday, I wrote about how annuities can be confusing, especially with hidden fees. I was wondering if it was possible for me to create something that approaches an annuity without the complexity and hidden fees, using investment vehicles that I know and understand.

I'm going to start with two important disclosures before I dig in:

  1. Annuities give you a guaranteed income stream. This is not going be guaranteed. The investment vehicles in some cases can lose value. The idea is that by diversifying amongst a few different option, you minimize that risk. And while annuities do give you guaranteed income, let's not forget the case yesterday of the annuity that charged more in fees than it paid out. I'd consider that a risk as well.
  2. At age 37, I'm focused on growth not earning an income off my investments. For those reasons, I haven't fully researched all the options available. Please be kind and helpful in the comments, okay?

For sake of argument, let's assume that you had a million dollars burning a hole in your pocket. (Just your typical scenario, right?) You are thinking, "I'd really like to put this money to work to earn me $40,000 a year." (See what I did there with the Rule of 4%?) How am I going to get there?"

Well, I've got three options for you to think about. I would suggesting allocating your money amongst all three.

  • Laddered CDs - That link gives some CDs that are paying around 1.3% interest. If you put your whole million there, you'd only get $13,000 to live off of. That's not a lot, but at least it is guaranteed.
  • Dividend Paying Mutual Funds and ETFs - I honestly had a little trouble finding documentation of the yield on a lot of mutual funds and ETFs, but I found this ETF tracker that has the top 100 yielding ETFs. I'd stick with something relatively safe that I've heard of like Barclays SPDRs which seem to have some options in the 5-6% range. Obviously this is the farthest thing from guaranteed, but at least the ETFs are diversified.
  • Lending Club - I've written before that I'm getting a 7% interest rate at Lending Club and it seems like most people are doing better than me. Some people will say that Lending Club is too risky because it hasn't been around very long. You are relatively protected if they go out of business. Also a significant investment allows you to diversifying amongst thousands of loans, making it fairly protected (though if the entire economy goes Mad Max on us, they probably won't pay). Finally, there are institutional investors putting big money in Lending Club. It isn't as absurd as it sounds to do the same.

If you were to mix the three options equally, you could get around a 4.6% return. On that million dollars, you'd have $46,000 in income. As for fees, they are fairly transparent. Most CDs don't have fees unless you withdraw the money early. The ETF that you choose will have an expense ratio that will disclose the fee. Finally the Lending Club servicing fees are outlined on the website. You aren't going to get in a situation where some hidden fee is going to sap your million dollars.

Let me know what you think in the comments. What else should/could be included in here? Treasury bonds?

Last updated on March 13, 2014.

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2 Responses to “Create Your Own Pseudo Annuity”

  1. Ben says:

    This won’t work with a million dollars because of the annual limits but we personally choose I-bonds over cds, at least with today’s low rates. They pay the rate of inflation, which is usually over 1.3% and are guaranteed by the US government. You can do 10k plus another 5 from your tax return, so 25-30k per couple annually.

  2. Ben says:

    I forgot to mention they are also not taxed on the state level and on the federal level tax is deferred until they are redeemed, allowing them to grow much more over time.

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