Cost of Doing Business (Part 2)

I believe clients pay millions of dollars every year to have money invested less effectively than they could do themselves. Rather than seeing this as financial-industry brainwashing, however, it may be a simple cost of doing business.

Two necessary components must be in place if the financial industry has indeed perpetrated a brainwashing of the American public. Even if the vast majority of people believe in domain-specific expertise, “brainwashing” implies a widespread propaganda campaign run by the financial industry. I’ve had some casual conversations with investment advisers and I read financial journals regularly. The brainwashing assertion seems too far-fetched for me to accept.

Here is a more positive perspective: investment advisers work as intermediaries. If I am going to pay someone else to replace my brakes then I will pay more to have it done. Similarly, if I am going to hire an adviser or fund operator (by purchasing shares) to invest my money then I will pay more to have it done. The added cost comes in the form of management fees, operating expenses, and lower returns as a result of less-efficient strategies.

Neither financial professionals nor the financial industry are to blame in this new paradigm. The industry is doing what clients ask them to do: invest money. Compared to the alternative—leaving money in savings accounts or under the mattress where inflation-adjusted returns are negative—the industry is doing a good job. Financial professionals may not match the performance of self-directed investors but time is required to learn and to do it for oneself. What you gain from being self-directed is partially offset by the time and effort committed.

In the new paradigm, this is about sweat equity. Those skilled at the trades (e.g. carpentry, plumbing, electrical) are in a good position to invest in real estate because they can fix things cheaper and realize a lower cost basis on property. Those with a penchant or aptitude for math and finance can invest/trade and realize a lower cost basis as well. Those who don’t must leave it to the professionals. In doing so they will pay a premium to have done what they can’t do themselves.

And they will be willing to pay the premium because that is how our capitalistic society works. It doesn’t have to be about manipulative brainwashing; it can simply be about appreciation and gratitude for a service.