Financial research drives industry product development, but not necessarily toward the best interests of individuals
Personal financial decisions seem to have become very complicated. To add to the confusion, the financial services industry develops an unending array of supposedly innovative new products. However, a large part of the complexity that individuals face results from the proliferation of repetitive financial products in a myriad of flavors with different features and different financial trade-offs. What is “best” and “right” for individuals easily gets lost in the ensuing confusion.
Well-educated specialists in the financial services industry have been the primary non-academic consumers of academic research in finance.
Creative “sell-side” professionals select from this research to develop sometimes innovative, but most often simply repetitive financial and investment products for sale to “buy-side” institutions and to individuals. The institutional “buy-side” of the financial industry tends to be more knowledgeable and discerning consumers of these innovations, when compared to individuals. However, in turn, the institutional “buy-side” of the industry also develops innovative and/or repetitive financial products and services, and then offers them to individuals either directly or through the financial advisor network.
Along this chain, objective academic knowledge of what is “best” and “right” for individuals tends to morph into product development and sales strategies that appeal to people’s personal insecurity, greed, and ignorance. Sales messages pander to people’s frustrations and need for simplification of what the industry itself has turned into a highly complex subject. In addition, along this chain of financial product development, many offerings to individuals tend to pick up extremely undesirable characteristics, in particular, high risk and high costs. Furthermore, products and indexes may be developed to exploit erroneous investor beliefs, such as trend extrapolation related to superior historical performance.
The Skilled Investor believes that much of the financial product complexity that individuals face is unnecessary and can be dispensed with through use of scientifically based product screening criteria. Much of the complexity that individuals face results from the proliferation of repetitive financial products in a myriad of flavors with different features and different financial trade-offs. In an often highly arbitrary sales process, industry agents attempt to sell this vast array of financial products to consumers. Without doing highly personalized and sophisticated needs analysis, a thin veneer of ersatz financial planning is offered. This faux financial planning is followed rapidly by a “consultative” sales process that usually pushes excessively risky and costly products.
In their pursuit of sales compensation, it does not really matter to many sales agents that your particular financial needs are square-shaped or octagonal-shaped. You are the sales prospect at hand. If you are susceptible to the sales pitch du jour, your real financial needs may get hammered into the round hole that that a particular sales person has a personal financial incentive to fill. What is “best,” “right,” or even appropriate to an individual’s needs and circumstances may take a back seat to making the sale.
After intelligent individuals wade through the intricate tradeoffs between financial alternatives, decision fatigue is highly likely. It is no wonder that many people just want someone to trust who will give them a simple answer to this largely industry induced complexity problem.
Because the preceding paragraphs might seem to have a cynical tone, it may be necessary to remind you that there are many, many thousands of good and ethical financial advisors in the profession. Furthermore, scientific studies of the practices of individual investors who lack good advisors have demonstrated that many individual investors are sorely in need of competent help. (See: What is the cost to individual investors of sub-optimal portfolio diversification?) With that in mind, however, you should be very careful about your advisor selection process. Unfortunately, some financial advisors really do fit the description of the previous paragraphs. (See: Preparing to interview a financial planner or investment advisor)
You might like to read a recent and very enlightening study that touches on some of the problems discussed above. After reading this study, you might change your mutual fund buying habits and save yourself substantial sums of money for the rest of your life. In this Harvard Business School finance working paper, “Assessing the costs and benefits of brokers in the mutual fund industry,” Professors Bergstresser, Chalmers, and Tufano analyze the value-added of the broker sales channel for mutual funds.1 In their conclusion, they state that “We begin with a positive hypothesis: the prominence of funds sold through brokers implies that brokers provide consumers with valued services. Our study has identified few, if any, of these benefits.”
This is a rather stark conclusion, when you consider that the great majority of mutual funds are sold through brokers and other financial advisors. In buying mutual funds through brokers and advisors rather than purchasing them directly from fund companies, individuals incur very substantial front-end or back-end sales load charges, and they pay substantially higher ongoing fund management and marketing expenses. Individual investors unnecessarily waste billions of dollars every year by purchasing mutual funds through brokers and advisors rather than buying directly.
Tags: investment advisor
Personal Financial Planning
- Hitting the Citibank Stone Wall in Polite Conversation (PIRATES OF THE CREDIT SEA - Part 4: Hitting the Citibank Stone Wall in Polite Conversation
This article continues my personal saga of trying to get Citibank to fix problems with their management of my credit card account with them.
For a summary of the overall situation, go to Part #1: My Treasure Is Taken!
For an article [...])
- Diversify with Low Cost Index Mutual Funds and ETFs Only (
During the last twenty-five years of the 20th century, mutual fund and exchange traded fund portfolio assembly costs declined dramatically.
Brokerage commissions were deregulated in 1975, and transaction costs have fallen very dramatically since then. Furthermore, well-diversified, low-cost index mutual funds have now become commonplace, while none existed in 1968. The mutual fund industry was still [...])
- Have You Given Enough to the Financial Services Industry? (
Why don't we hear about the real financial sector scandals, which are exorbitant fees and costs that cause a continuous wealth transfer from individuals to the financial services industry?
This article follows a recent article entitled "The Financial Services Industry is Still the Largest S&P 500 Sector - Even after the Collapse of its Stock Value." [...])
- The Heavy Burden of Recurring Investment Expenses and Fees – Part 2 (
The heavy burden of recurring investment fees (Part 2 of 2)
< < -- Go to Part 1
By charging fees as a percent of your assets, the investment industry can make their recurring fees seem small – like they are “just a few” percent.
Furthermore, by charging fees against your assets the industry can still bill you [...])
- Default under the Citibank Credit Card Contract (PIRATES OF THE CREDIT SEA - Part 6: Default under the Citibank credit card contract
This final article in this series discusses the seven conditions of default under the Citibank / ATT Universal card agreement.
It also expresses my opinions about contractual relationships in general and about the Citibank / AT&T Universal credit card contract in particular.
- Develop Your Own Personal Financial Planning Skills – Step 1 of 10 Financial Planning Steps in the Right Direction (You are completely responsible for your financial and investment success or failure. Delegating investment decisions to industry advisers largely on naive faith and hope without adequate personal knowledge, attention, and control can be very risky to your personal and family welfare. The only practical solution is for you to increase your personal investment knowledge and [...])
- The Value and Opportunity Cost of Your Personal Investment Management Time (
Your time is valuable, and it should be included in calculations about your investment returns.
Whether you add or subtract value from your assets when you spend time on investment activities should also be evaluated. Some investors spend significant time on the wrong strategies. Instead of adding value, their efforts reduce their investment portfolio performance and [...])
- The Biggest Personal Finance Story of the Past 30 Years (
The Biggest Personal Finance Story of the Past 30 Years - Part 1
What could the biggest personal finance story of three decades be?
The growth of mutual funds and ETFs? Nope.
The dot com boom and bust? Nope.
Vanishing pensions? Nope.
The not-so-high quality of mortgage bonds? Nope.
A 0% personal savings rate nationally? [...])
- Use Caution with Classical Investment Books (Use Caution with Classical Investment Books - A Tip from The Skilled Investor
Individual investors should exercise caution when applying the tactics of classical investment books to current markets. The more handcrafted, seat-of-the-pants, and individual actor approach to the securities markets in the pre-computer, pre-networking era has given way to different practices. What might have worked [...])
- What Is Investment Portfolio Diversification? (From the perspective of holding a well-diversified investment portfolio according to scientific investment principles, the objective of diversification is to minimize or eliminate ‘unsystematic risk’ or those risks that are not related to the price volatility of the overall securities markets.
When people speak of investment diversification, they may mean different things. Therefore, clear definitions are [...])
- California Investment S & P 500 Index Direct (SPFIX) pulls in a +8 Fund Authority Score (
The Standard & Poors 500 stock index is the most common equity index fund benchmark in the U.S. The S and P 500 tracks about 75% of publicly traded U.S. equity market asset value. The dominant issue in choosing among passively managed index mutual funds and ETF funds benchmarked against the S & P 500 [...])
- Understand Your Projected Expenses Over Your Lifetime (Do-It-Yourself Financial Planning - Understand your projected expenses over your lifetime
Increased savings through conscious expenditure reduction is the largest and most controllable factor in long-term personal finance success.
Anyone interested in improving personal financial planning must understand that tracking expenses accurately and comprehensively is very important. Exactly how your expenses are tracked is not so important, [...])
- Earned Income Drives the Personal Finances of Most People (Do-It-Yourself Financial Planning - Earned income drives the personal finances of most people
The ability to project your various income sources automatically over your lifetime is one of the first steps in creating a useful do-it-yourself personal financial plan. Whether from wages and salary or from self-employment, personal earned income drives the lifetime finances of most [...])
- 2006 and 2007 Personal Income Tax Rates for the 50 States and DC (
2006 and 2007 personal income tax rates for the 50 states and D.C.
The Skilled Investor has made available for downloading a spreadsheet that contains graduated personal income tax rates and other personal income tax rate information for the 50 states and the District of Columbia.
If you want to know about specific U.S. state personal graduated [...])
- I Want My Treasure Back Please (PIRATES OF THE CREDIT SEA - Part 3: I want my treasure back!! (Please)
What are my rights in the situation that I summarized in my previous article: "PIRATES OF THE CREDIT SEA: My Treasure Is Taken!"? Well, the answer is very simple. I have a contractual right to get my treasure back. I also have [...])