Free Investing Is the New Free Checking
Are you paying for checking? You totally don’t need to. Most Americans, at least, have access to a free checking account that offers many of the features we closely associate with a traditional investment account: secure storage of and access to money.
It’s not farfetched to ask the same question about an investment account and provide the same answer. Particularly for investors who own index funds (or “closet index” funds with low active shares), it’s becoming increasingly apparent that there is no need to pay significant fees for a diversified portfolio. Vanguard has long offered target date funds that combine their low-cost index offerings, but Charles Schwab’s “Intelligent” portfolios, which do not have associated fees, are a harbinger of what is to come.
I’ve already said that in the fight against algorithmic investment services, financial advisers “had better compete on something other than cost, accuracy, and speed” but haven’t yet taken that analysis further. My colleague Lauren Foster has noted that robo-advisers and financial advisers had better start getting along, but I will state that more strongly.
Charging for Non-Differentiated Investment Products Is About to Get Very Hard.
If you are selling the same thing as everyone else, and that thing is infinitely scalable at minuscule marginal cost — like many equity index funds — there is little reason for someone to pay you for it. A preponderance of services have evolved to combine various low-cost investments into “customized” investment portfolios, but those products have essentially the same characteristics. The algorithms that combine the products are as scalable as the products themselves.
This leads to a competitive dynamic that is easy to name but difficult to survive: a race to the bottom. Vanguard’s ownership framework, which is not designed to earn a profit, seems to be structured in anticipation of this competitive dynamic.
There is not going to be only one firm providing low-cost index funds, but it is difficult to imagine a true need for the hundreds of them that exist now. In 2012, Business Insider did a survey of S&P 500 index funds and found that Vanguard effectively dominated its competition. Businesses attempting to extract excess fee income from either these non-differentiated funds or the construction of a portfolio comprised of them will have a difficult time justifying their existence.
So Are Professional Investment Managers Going Away?
No way. Fortunately for investment professionals, we are not selling buggy whips. As long as there are organizations and individuals with money, there will be a market for figuring out what to do with it. That market is simply evolving, which is why Lauren’s framing of the next step for advisers as “getting on the right side” of the trend is so perceptive.
I have personally never been more bullish on the future of the investment profession, but that doesn’t mean it’s going to look the same. It’s unlikely that there will be many highly paid employees doing work that could easily be performed by algorithms in the years to come. Instead, look for small teams of investment professionals to be levered as never before by software. To me, it seems like there will still be ample room to provide products along one of three lines:
- Personality: A more pleasant interface to money management than is otherwise available. This can take the form of a trusted adviser, but also software that integrates more thoughtfully into your daily life. I imagine that many investors would pay for value-added services, particularly for things like life coaching bundled alongside financial advice.
- Performance: Pure alpha. Simple enough — there has always been a market for outstanding investment results and it is hard to imagine that changing. It will likely become more difficult for “closet indexers,” who are in essence pretending to provide active management, to pass by undetected, but many professional investors will probably welcome that development.
- Permanence: Advice for the wealthy centered on specific issues relating to their legacy. This currently includes considerations like trust and estate planning, but I imagine that it will evolve to encompass a range of products that are not currently widely offered, like charitable plans that rival investment plans in sophistication, diversification, and analytic rigor.
What have I left out? Do you see a vector where financial professionals can offer value above and beyond that provided by low- or no-cost indexing services? Let me know in the comments section. After all, “free checking” has been around for a while, and it would be difficult to argue that the retail banking industry has altogether gone away since then.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
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12 thoughts on “Free Investing Is the New Free Checking”
The new trend towards index funds will eventually lead to a group think and herd mentality approach to investing. That should offer more opportunities for value investors.
Thanks Chuck! I totally agree. The rise of index funds will make the returns to thinking for yourself greater and greater as time goes on.
All best —
I agree with your sentiments but I question how fast this develops. It seems as if you assume just about everyone is indexing. What about the less well-informed investors still along for the ride in mediocre active portfolios assembled by an advisor? Moving those trillions will take time as the low-cost messaging from index providers isn’t cutting through all the noise.
I agree that there will always be less informed invetsors for underperforming active managers to prey on. But there is a trend starting to develop. Just check out the increase in assets managed by Vanguard. There will be more aggressive marketing by index funds to lure the less informed.
I totally agree. Check out my response to Alex. I think that it’s easier to market passive services, since they seem “sciency” and play into a distrust that the public has of the investment business.
Thanks again for reading and commenting–please subscribe and check back often!
You raise a good point, but I’m not sure that everyone needs to switch to an index fund for advisers to need to provide more differentiated services. I sense (from both intuition and study) that there is substantial disaffection with some financial advisers among their clients, so regardless of whether index funds come to hold 98% of assets or not it feels important for advisers to focus on this.
I do tend to agree with Chuck as well though — I expect ad dollars to come out in force to support indexation over the next few years. As distinct from active management, it’s marketable as an almost scientific product which holds a lot of appeal.
Many thanks for reading and commenting! Please subscribe and check back often.
All best —
As always in terms of software, accessibility for end-user will be a key success factor.
Investment dinosaurs aiming to go online developing complex web interfaces with too many parameters should have a hard time competing with innovative and low-fee firm launching user-friendly smartphones apps.
After all, investing your money shouldn’t be harder than signing a check. 😉
Thanks! I’m glad you like it. I agree that a good user interface makes all the difference, and you’re right that signing a check should be the usability bar that consumer financial products are held to. I think that many financial products–especially those dealing with checking/savings or small dollar investment accounts–are too focused on customizability at the expense of usability.
I’m glad you liked it! Please subscribe and keep reading. All best.
“So Are Professional Investment Managers Going Away?1” Actually the answer is both yes and no. Yes, there most likely will be fewer firms. No,
in that there will always be a segment of the population that requires assistance and/or is willing to pay for it. Be it trust or estate planning or simply not wanting to deal with the time it requires to manage a portfolio.
Indexing as a core, in my opinion, is a balanced approach to long term growth.
Placing a percentage of assets in well researched managed funds gives you the exposure to do better than just average, albeit at a slightly higher cost..
I think you frame it very well! Many thanks for reading.
All best —