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. Yeah, it’s true – expenses 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. 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. 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. But 1.66% 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 causing too much destruction 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.
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