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Pragmatic Capitalism

Practical Views on Money, Finance & Life

Modern Finance is (Still) a Rip-Off

I’m going to tell you a secret that most of my industry doesn’t want you to know – modern finance is a rip-off. We call it “modern” finance, but the only thing that’s modern is the technological advancement. The fee structure remains antiquated. Yeah, it’s true – expense ratios and costs are falling rapidly. For instance, equity mutual funds have seen a 31% decline in their average expense ratio in the last 15 years.¹ But that has comprised a decline from very high levels to merely high levels. And when you run through the numbers the amount of grift here is disturbing.

According to the 2016 ICI Factbook there is more than $18 trillion in registered investment companies in the USA. Of this, $15.7 trillion is in mutual funds. Within this space the average asset weighted expense ratio is about 66 basis points (it was almost 100 bps 15 years ago). That’s 66 cents of every $100. Bear in mind, this includes the index mutual fund space which costs about 10-11 basis points. So, if we look at just the mutual fund space there’s about $100 billion in fees that are coming out of client accounts every year.

Now, keep in mind that most of these funds are closet index funds. We know that about 87% of active mutual funds don’t beat a correlated index.² In other words, these are mostly worthless funds that are owned by uninformed investors. So, if creative destruction actually worked then we could wipe out most of these funds and the average annual fees paid by these fund owners would drop to a total of about $16 billion. That’s still a lot of money, but nowhere near as high as it is today.³

It gets worse though. You have to keep in mind that most financial advisers are charging about 0.9% these days for what is basically high fee asset management using underlying mutual funds or index funds with an occasional dollop of financial planning. So, on top of the 0.66% in fund costs many investors are incurring another 0.9% in advisory fees. Granted, this probably pays off for many investors who actually need the coaching and structure implemented by a good advisor, but 1.56% of your assets per year is an egregiously high cost for what is essentially the equivalent of having a personal trainer for your portfolio.

Of course, Wall Street doesn’t want you to know this and I am making no friends by writing this. Heck, I don’t even fully want you to know this because I am pretty sure there’s a robot somewhere someplace just waiting to make me obsolete. But this is a secret that I feel morally obligated to expose because it’s contributing too much hardship to too many people’s lives.  Hopefully the downward pressure on fees will not just continue, but accelerate. And along the way we’ll become an industry that still earns a decent living while adding real value by being true fiduciaries for the people we work for.

¹ – See the 2016 ICI Factbook.

² – See the 2016 SPIVA Scorecard.

³ –  Keep in mind, this is just the mutual fund space so I am not even including all of the high fee funds in the closed-end space or the ETF space.  

Cullen Roche

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC.Orcam is a financial services firm offering low fee asset management, private advisory, institutional consulting and educational services.Cullen is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.
Cullen Roche

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