WE WERE DISAPPOINTED to read this morning an article, recently published in the hallowed pages of USA Today, which wastes a great deal of ink discussing the proposition that large financial-services firms screw over their small-potato customers. The article did not use that particular turn of phrase, but that sentiment is clearly expressed within it. A pity the whole idea is crap.
It is also a pity that the article was inadequately researched, unfair in its tone and scope, and offers up some truly awful advice to boot. The USA Today article starts out with a swipe at the Vanguard Group -- Vanguard, for God's sake -- and proceeds from there:
Come to the Vanguard Group with $1 million or more, and you get portfolio advice, low fees and a personal representative to attend to your investment needs.
Come to Vanguard with $10,000, and you get a guy on the other end of the phone.
Come with less than $1,000, you get turned away.
Vanguard is typical. Increasingly, the message from Wall Street is that small investors need not apply. Merrill Lynch, which once bragged about bringing Wall Street to Main Street, requires a $100,000 ante to sit down with a broker. And Charles Schwab, pioneer of discount brokerage, pushed up fees on small accounts in an effort to make them be profitable — or go elsewhere.
Nearly every brokerage, brokerage house and bank has a special team that caters to the wealthy. Small savers, on the other hand, pay more for their investments, get little advice and often get the raw end of investment scams.
All of which could be dismissed as the way the world works, except for one thing: Today's small investors aren't the stock dabblers of a few decades ago, who bought and sold stocks for the thrill of playing the market. They're investors because they have to be. Their retirement depends on it.
Pensions, once a mainstay of retirees, are disappearing. Just 17 percent of all private employees have traditional defined-benefit pensions, according to the Employee Benefit Research Institute (EBRI), a nonprofit research group. That's down from 44 percent 20 years ago.
The first immediate problem we saw with this was simple -- there are companies which do welcome investors with less than $1,000 to invest, even in a taxable account. One of them is Scottrade, a fast-growing private brokerage firm which requires just $500 in cash or equities to open an account. Online trades are just $7, and investors can get personal attention at any of the firm's hundreds of offices. All they must do is walk in. Therefore, we can see Scottrade's service would be wonderful for any truly small investor who is just starting out, and wishes to build his account over time via monthly contributions. It would have been nice had the article pointed out there are companies which do cater to regular folks.
The second immediate problem we saw was that certain ideas were glossed over. Yes, we realize we are discussing USA Today, but that's still no excuse: one sentence would have done the trick in fixing these problems. For instance, when the writer points out that "nearly every brokerage, brokerage house and bank has a special team that caters to the wealthy," it might have helped if the writer had mentioned why. Oddly, he does not do so until the end of the story, and even then, he doesn't really explain it.
The answer is simple: due to deregulation in the financial-services industry, all these firms can now compete for this small but lucrative market. It is entirely feasible for, say, Wachovia -- or, as Simon From Jersey has jokingly called them, Watch-over-ya -- to handle every aspect of a customer's financial life. And because competition for this limited market is so fierce, firms must offer such services lest their clients jump ship.
The third immediate problem is the article's cavalier dismissal of the profit motive. Attention, USA Today: brokerage firms are not charities. They never have been. Fred Schwed had that figured out back in 1940, so there's no excuse for your man not to have done so six decades later. But apparently it is impolite these days to suggest that firms might actually be doing a good thing in carrying these accounts which generate no revenue or actually cost them money.
And the fourth is this wailing and gnashing of teeth vis-a-vis pensions. We are not generally enamored with pensions, as we find them a post-war anachronism in today's information age. Pensions made sense back in the Good Old Days, when tax-advantaged retirement accounts did not exist, and as such they're great for older workers. But as those tax-advantaged accounts do exist now, we -- being a young worker -- do not think pensions are as great as they once were. Yes, the guaranteed income with a defined-benefit pension is nice; but young workers could make far more money on the defined-contribution side of things. Besides, when workers die, so do their pensions. That sucks.
Anyway, as we said, these were things we immediately saw wrong with the article. There are deeper, more insidious things, as well -- and we think we ought point them out lest bad ideas go uncriticized.
The first is this idea that people should start brokerage accounts with small money. In some cases, it's not a bad idea -- for instance, if one wants to use "dollar-cost averaging" to build up an account over time. If Small Investor A wishes to open an account with $500, and put that into Index Fund B, and supplemented that with monthly contributions, it's not a bad idea. But in most cases, the idea that an investor would put $500 into an account to buy shares in a single equity is ridiculous. Furthermore, we have to ask, just as Tobias and all the other gurus have asked: if you don't have $1,000 or $3,000 in ready cash to put in the market, what in hell are you doing opening an account? You would be better off putting that money in a savings account for emergencies, so you won't have to dip into your retirement funds should an emergency arise. We should also stress that we used the phrase brokerage account -- there's a difference between that and a retirement account, e.g., a 401(k).
Our second complaint deals with some of the patently stupid examples which the writer uses. Specifically, he mentions investment in one of the "hottest" broker-sold mutual funds, which charges poorer clients a higher percentage commission than the wealthy. The gurus again have noted: why the hell would anybody buy a mutual fund and pay commission to get in it? You've lost money from the get-go with that approach. Investing in an exchange-traded fund, on the other hand, offers virtually expense-free investing (expenses are often between 0.1 and 0.2 pc per annum, depending on one's firm) and there are no percentage commissions.
Lastly, though, we must say we don't like the writer's thinking that financial advice is really worth all that much. Anyone with funds in the market must deal with those matters seriously, and that means an investor needs to take the initiative in learning how to do his own research. In short, he ought arm himself with the tools he needs to be successful. It may not be the most fun thing in the world, but he will be better off for it. Quite frankly, we would be greatly surprised if these well-off investors, the seven-figure types, used their personal account representatives simply for advice. More likely they come in handy for smoothing out administrative details and such.
But as we do not want to end on a negative note, we do want to point out one thing which we thought USA Today's man did right. He should have devoted more space to it, perhaps even written an entire article on it. It, in this case, is the fee-schedule with which investors in some 401(k) plans often get stuck. There is a lot of capital being wasted in such plans just due to the unnecessarily high expense ratios. We think people would be served well with an examination of these expense ratios, as they could then shift their money into those available funds with smaller expenses.Posted by Benjamin Kepple at September 25, 2004 10:13 AM | TrackBack