Why Most Banks Wouldn’t Survive Without Scamming People
Learn to protect your assets
News flash: That attractive financial advisor at your bank doesn’t have your best interest in mind. Shocker! And here she smiled at you so warmly.
Like most people, I’m not terribly interested in the bottomless pit that is finance. It’s a complex world. And someone is always looking to profit from your obliviousness.
So we put our share into the S&P500, ETFs, or whatever else safe asset that’s relevant to us and our country of origin.
But it turns out that even playing it safe can be treacherous.
When I was sixteen, my mother gave me a key piece of advice. She pointed out a few index funds and said:
“Put your money here. Don’t bother with the other funds you see.”
At the time I didn’t really care, I was young. I thought she was acclaiming the old platitude of keeping your investment in one place and not hopping around to lose out on long-term benefits.
Little did I know of a concept called management fees.
Now, you might already be well familiar with those. But you might not have realized the severe, deceptive nature of how they affect your investments.
What do your investments look like right now, when you’re reading this? Have you thought through what you’re paying for vs. what you’re likely to get back?
Let’s explore why banks:
- Employ a business model that actively screws you over
- How they profit off the unaware
- How you can protect your money from their grubby hands
Let’s get started.
The Treacherous Business Model of Most Banks
Most banks that offer funds operate on what’s called a “kickback model”.
The model revolves around selling expensive funds to unassuming customers and then keeping part of the management fee as a rake-off.
This means they earn more money the more expensive funds you invest in, creating conflicts of interest.
Actively managed funds or simply active funds are equity funds with a team behind them. This team analyzes companies and actively makes investment decisions in the fund to beat the market. This is in comparison to an index fund, which just coasts along the evolution of its index.
You can bet these teams cost major moola. This drives up the management fees.
If you’ve ever used a bank’s investment portfolio generator, these are the kinds of funds you’ll almost ALWAYS be shown. Wonder why, huh?
I experimented with one of the banks I use. I used their generator to generate the most long-term portfolios, titled “Future 10–20 years ahead”.
This is the result:
The typical and rate-of-return-friendly index fund is around 0,2% in fees. They didn’t do too bad as this is one. But it’s still egregious recommendations when you think about the fact that long-term investments are supposed to be the safest.
Naturally choosing some growth options is good, but this is going to come out to an average of 0,98% in fees.
If you invested well and grew to $20,000 in 10 years with an annual fee of 0,98%, that’d come out to a fee of $196/year. Meaning you’d have lost $1960 in fees on average.
And this is considered one of the banks in my country with the most reasonable fees…
If one were to put it harshly — you could say the ones of us who know what we’re doing get a really cheap service from these banks BECAUSE they‘d probably go bankrupt if everyone invested intelligently and/or only chose cheap index funds.
You’re getting your dirt cheap investment of the back of some clueless joe the bank signed a 3% annual fee to, all while patting himself on the back. Joe finally took his finances into his own hands… yay.
Are Actively Managed Funds Even Worth It?
You’d think a project backed by a team of full-fledged analysts would fare better than the braindead shuffling of an index.
Well, sometimes they certainly do outperform.
A study done by scientist Russ Wermers concluded that some active funds can pick stocks to beat the market. The problem was that the administrative cost for the funds was too big to be profitable in comparison to their indexes.
Another study by Otten & Wams who examined 500 funds on the European market from 1991–1998 strengthened that it was possible. Only for them to conduct a second study in the years 1992–2006 showing that the actively managed funds performed worse than their comparative index, but better than corresponding index funds.
Then we have Morningstar, the world’s biggest independent publisher of investment fund info. They regularly compare passive and active fund managers.
Below you find an excerpt from the American stock market:
(The image shows how often active funds beat index funds in the same category during different periods. For example, in the category “U.S Large Blend”, only 21.6% of active funds have been better than their index fund counterparts)
They give a clear message — only in 20–30% of cases did the active funds beat their passive equivalents. That’s a garbage result.
To get a view of the European markets, you can use the analytical tool from Standard & Poor and their yearly comparisons. I’ll spare you the journey though — it looks equally bleak for European actively managed funds as the American ones.
The takeaway? Actively managed funds are just an overall risky game.
Are There Any (Better) Alternatives?
Yes, actually.
Viable alternatives? Questionable.
Some banks are looking to revolutionize the world with kickback-free models. Much like Medium, they are experimenting with taking out a flat platform-based fee.
They technically take in kickbacks, but they quickly funnel the money to you, the customer.
Unfortunately, this means that if you stick to your guns and invest in low-fee funds, the total cost will often be higher than if you had just invested with a regular bank that doesn’t charge a subscription fee.
Until someone rises against capitalism and bank officials lining their pockets, you’re best off finding a bank that’s the least bad out of the dung heap.
The Takeaway
Don’t throw away your money just so fund managers can get richer.
If you’re going to go above a generally safe and profitable management fee of 0,2%, make sure to do your research. Adding some growth potential to your portfolio can be a good investment but it has to be balanced out with safe bets, and bets that don’t overlap with each other unnecessarily.
And most of all — don’t equate expensive with “better”.
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