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? Nope. (But, that is a strong contender.)
To break the suspense, the biggest personal finance story of the past 30 years has been the dramatic growth of the market capitalization of financial services firms within the U.S. equity markets!
Huh? Why is this so important to personal finance? Why should I care, if the market capitalization of the financial services sector has grown dramatically? That certainly does not sound as cool as trading to beat the markets, craving hedge funds, betting on commodities futures, or even tossing Paris Hilton and Lindsey Lohan into the slammer.
Well, the reason that this is so important to your personal finances is pretty straightforward. Simply put, most individuals pay far too much for financial products and services. Their continuing overpayments show up in the increasing value of financial services company stocks. People have paid far too much for years, and the industry’s excessive charges have been increasing for years. (See these related articles on The Skilled Investor website: Controlling Investment Costs )
In return, individuals receive far too little. Exorbitant and increasing investment costs, high banking fees, predatory credit card charges, excessive insurance costs, etc. simply represent a massive wealth transfer from the personal pocket books of average individuals into the coffers of the financial services industry and into the high paychecks of their employees.
Name the one industry that has a reputation for high salaries and bonuses, which the media trumpets to you like this is somehow good news and worthy of envy. That one industry is the financial services industry and, particularly, the securities segment of the financial services industry. Yet, even after financial services companies have paid these huge personnel expenses and even after they have paid for all those high end commercial office buildings with shiny brass, plate glass, and mahogany furnishings, the financial industry is still highly profitable. Financial services sector profits and earnings growth rates have made this the largest sector of the S&P 500 stock market index!
I hope that by now I have your attention. Understanding this situation is very important to you. Taking action to reduce the costs of financial products and services that you buy is critical to your pocketbook over your lifetime.
To understand what has happened to the market valuation of the financial services sector, particularly over the last 30 years, you should view Figure 4 on page 16 of the financial study by Jeremy Siegel and Jeremy Schwartz entitled: “The Long-term Returns on the Original S&P 500 Firms.” [Note that this is an Adobe Acrobat document on The Wharton School of Business website at the University of Pennsylvania. Be patient and let it load.]
The next part of this series of articles will discuss the meaning of this Figure 4 graphic in the Siegel and Schwartz paper. Stay tuned via the RSS links in the right-hand column.
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Comment by Lazy Man and Money
1 August 7, 2007, 12:17 pm o'clock |
Most of that money comes from companies, not personal finances. Goldman Sachs had a record year last year and how much does the average person have invested with them? Nothing. It’s all from investment banking. I’m not saying that Vanguard is poor by any means, but they earn a fair profit for a fair service. If any person or company can do better, they are welcome to try in the open market place. Rather than complain about how much they are making, you should join them and exploit the any inefficiencies in the free market. Only by doing that will it bring the costs down.
Comment by The Skilled Investor
2 August 7, 2007, 1:01 pm o'clock |
Hi Lazy Man,
Thanks for your comment. I plan to write additional articles on this particular topic in the near future to get into more specifics. You have anticipated some of my themes. In particular, the only solution that a cost-aware individual has is to invest with the lowest-cost vendors, such as Vanguard. While individuals protect their own pocket books, they can also benefit from the market capitalization that flows from excessive and unnecessary investment costs paid by individuals and organizations.
In the securities sector and in other segments of the broader financial services industry (banking, insurance, etc.), the excessive financial cost numbers do mix both the impacts on individuals and on businesses/institutions. In general, businesses and institutions at least have the potential knowledge and incentives to negotiate a better deal, although many organizations do poorly at this.
Excessive financial costs paid by businesses and institutions that are not negotiated down have a similar wealth transfer effect — just as excessive costs do with individuals. Instead of showing up as a lifelong reduction of a person’s assets, excessive costs paid by businesses show up in a reduction of profitability and downward pressure on a firm’s equity price and in a reduction of cash flow, which influences the cost of debt.
However, individuals seem to need much more counseling about the negative impacts of excessive financial product and services costs. The numbers in research studies indicate that the average person pays excessive costs that substantially damage their lifetime finances.
In addition, the problem is much wider than just securities. Excessive costs are a very significant consumer problem with banking, credit in its many flavors, insurance, etc. The educated and cost conscious consumer has the advantage here. As you suggest, cost conscious consumers can exploit the inefficiencies. However, given the history of rising financial costs, I am skeptical that the majority of people will ever get the “low-cost financial products religion” and thereby drive down financial service industry costs. The financial industry employs some of the best and the brightest, who will work diligently and creatively to ensure that this wealth transfer process continues to flow strongly in their direction.
Thanks,
The Skilled Investor