If you were told that a smoker would die on average ten years younger and more painfully than a non-smoker, would you do it? Some would take that chance just for the short term pleasure of living for the moment as it were. For others that’s a ridiculous idea, to intentionally raise the risk of shaving a decade off one’s life.
And yet, people ignore how harmful costs are to their financial health. They think nothing of paying 18% interest when they don’t settle their credit card bills. Where can you get a stable 18% returning investment today? Well, that’s what credit card companies are getting from non-payers.
They gloss over the fact that they pay fund managers the equivalent of maybe close to 20% of long-term expected returns on funds they buy. They are liable to pay maybe half of one year’s returns to the person who sells them investments. Fees are perhaps the new cholesterol (which apparently is no longer on the naughty list for heart health some research say) for investments.
By the way, 20% of your returns per year vanished to fees result in one-third less in your wealth at retirement, assuming saving over a 30-year career.
The irony is that smokers know more about what they are getting into than say a unit trust investor or an insurance policy buyer. Financial product consumers think that that’s the way it is, that it’s either existing offerings or doom. They think that paying these costs are part and parcel of what people do.
Well, it is but not everywhere.
In the US, people have poured $3 trillion into exchange-traded funds or products. They realise that smoking and high-cost funds are bad. Of course, much of the money goes into highly speculative trading but it’s undeniable that cheap ETFs are becoming accepted as an excellent way to invest when you have, say, the Vanguard funds charging you fees of 0.2% and below with zero sales commissions.
In the Malaysian insurance industry, people are also waking up to the fact that they don’t have to pay 171% of the first year’s premiums in commissions (paid over a few years). Savvy insurance buyers are flocking to plain vanilla term policies where premiums are a few bucks and not a few hundred a month. The savings can then go into long-term investments, powerfully establishing a kind of self-insurance for the future.
Of course, nothing comes for free. Salespeople and agents who tell you stories about financial products or supposedly advise you need to be paid. Some agents are worth their salt. But this is where you have to decide whether a high-quality advice was given.
But something else radical is happening. The innovation in the digital economy today is enabling informed decisions cheaply. It is making people question the very definition of what ‘advice’ is when you pay only 0.2% a year or less for your investments rather than a one-time 5% sales fees plus 1.5% management fees a year.
There is also rising awareness of fee-only advisory. For instance, paying RM1,000 (please feel free to replace with a more relevant currency of choice) for 3 hours of financial advice is equivalent to paying 5% on a RM20,000 investment based on existing expensive commission models. But in the fixed fee model, you are charged the same advisory fee whether the investment is 20k or 200k. Further because of the fixed-fee model, the financial planner or advisor isn’t motivated to push only the most profitable products.