Dear Mr. Berko:

My wife and I are both 77 and recently sold our home for $266,000. The only income we have is Social Security, one state pension and a small insurance check. We need income. Our nephew is a broker with a big New York Stock Exchange member firm and has suggested that we invest $100,000 into an index annuity from which we can get $10,000 a year. He has recommended that we put another $100,000 in his company’s reverse convertible securities, which will pay us 14 percent each year. It seems that our money would be in two “win-win” investments.

F.E., Joliet, Ill.

Dear F.E.:

You may not want to believe this, but those investments are a “win-win” only for your darling nephew, who has no more conscience than a fox on a poultry farm.

I’ve watched many of the biggest New York Stock Exchange firms greedily vend some really unsuitable products (rare coins, real estate tax shelters, drilling leases, rare art programs, Hollywood movies, jumbo-jet partnerships and heavy-equipment leases, to name a few) to an over-trusting clientele. In my opinion, the typical indexed annuity ranks down there with uranium mines, bio-waste plants and other egregious Wall Street products. But even a semi-honest broker would find it difficult to resist commissions that can be as high as 12 percent.

The income this immediate annuity earns is tied by a complicated formula (which I can’t understand) to the stock market. I can tell you that the income, which accrues each quarter, cannot be paid on demand. The language in the prospectus says that it must remain in the contract for eight years prior to being paid out. Did your nephew explain this to you?

Though you can withdraw 10 percent of your principal each year, there’s a catch. Did your nephew explain that when you take out $10,000, that money earns zero income for the entire year, even if you take it out in December? And if, the good Lord forbid, you need to get your hands on $50,000 due to a family crisis, your annuity company will blast you with a surrender fee of 20 percent. I don’t suppose he told you that, either.

Finally, the annual costs (3.5 percent) are high enough to choke a giraffe. They’re outrageous, flagrant and a millimeter away from bordering on criminal. I don’t know of a single index annuity investor who is pleased with his index annuity.

A reverse convertible security is a short-term investment (usually 12 to 24 months) that is linked to an underlying stock like Boeing Co., Bank of America Corp. or Intel Corp. These securities have a predictable income stream (usually 9 percent to 15 percent), and at maturity the investor gets either (1) all of his money back plus interest or (2) a predetermined number of shares of underlying stock plus the interest.

Option 1 is the better choice, but the investor usually gets stuck with option 2, in which the market value of the received shares of underlying stocks is worth less than your original investment. An increase in the market value of the underlying stock does not increase the return on your investment. The attraction of this product is the high rate of interest, and the danger is a very possible loss of principal.

In many cases, these products may not have a secondary market if you need to liquidate. Though the potential return on a reverse convertible appears attractive, it’s likely that the real return will be significantly less than you were told by your nephew.

I suggest that you locate a broker who understands your goals and cares more about how well your investments perform than about the size of his commission check.

Please address your financial questions  to Malcolm Berko, P.O. Box  1416, Boca Raton, Fla. 33429 or  e-mail him at malber@adelphia.net.  © Copley News Service