There was an interesting and slightly scary article in the Wall Street Journal recently, in which reporter Andrea Fuller tries to find out what fees she’s paying to the financial adviser who manages her money. At long last, after a torturous experience with the company, she finally manages to find out how much she’s paying — 1.4 percent of assets every year, with 0.85 percentage point of that going to the advisers who manage her investments, and 0.55 percentage point to the funds they invest in.
To pay 1.4 percent a year is an absolutely enormous amount. As I demonstrated in a piece last year, even a tiny fee can devour a huge percentage of your life’s savings.
As you can see, if she doesn’t withdraw her money for 40 years, Fuller could end up paying a third of her entire lifetime savings to her investment adviser and the funds he invested in. Other than possibly her house, wealth management will be the single most expensive thing she ever buys.
What is Fuller getting in return for this huge expenditure? Her financial advisers have little chance of beating the market, so if they’re sensible, they’re investing most of Fuller’s money in highly diversified funds. But this is something Fuller could do herself in a couple of hours — just go to Vanguard Group’s website and buy some of its low-cost index funds and exchange-traded funds. Those charge barely any fee at all. If Fuller is paying double-digit percentages of her life’s savings for something she could do easily by herself in a short amount of time, then to say she’s not getting her money’s worth is an understatement.
Of course, if she invested on her own, Fuller might not do the sensible thing. She might pick individual stocks, try to time the market and make all the other mistakes individual investors tend to make. In doing so, she might squander even more of her potential wealth. So by preventing her from making a hash of her finances, the adviser might be earning his keep.
But that’s no excuse for the lack of price transparency that Fuller documented. If even a seasoned financial reporter has to spend hours just to find out the price that she’s paying for one of her most important lifetime purchases, something is very wrong with the market for wealth management.
Free markets can’t exist when people don’t know what prices they’re paying. Economist Friedrich Hayek, a celebrated proponent of the free-market system, said that prices are important because they provide consumers with information about supply and demand. Without that crucial information, buyers can’t know if they’re getting their money’s worth. Basic economic theory supports this — knowledge of prices is a necessary requirement for markets to reach efficient outcomes. Wealth-management fees can be hidden for several reasons. First, as Fuller’s experience shows, it may simply be difficult to get a company to tell you how much you’re paying. But even if they do tell you, you may not realize how steep the price really is. The tiny annual percentage number can mask the fact that the fees add up over the decades — you may think “Oh, 1.4 percent is pretty low,” when it actually means a third of your life’s savings over 40 years. Also, many investors probably don’t know the difference between fund expenses and the fees paid to advisers — you might feel triumphant about being invested in low-fee ETFs, only to ignore the huge percentage fee you’re paying to the person who picks those ETFs for you.
I suspect that these quasi-hidden fees are a huge reservoir of financial dark matter — a giant slush fund that feeds many of the excesses in other areas of finance. Fees paid to wealth managers get passed on to hedge funds, private-equity funds and high-expense mutual funds that the wealth managers invest in. From there, they go on to fuel the curiously high salaries of traders, portfolio managers, executives and even the secretaries working at
No one knows how much of the financial sector’s increased share of the U.S. economy comes from hidden wealth-management fees, but a quick back-of-the-envelope calculation shows that it could be a lot. The combined capitalizations of the US stock and bond markets were about $65.8 trillion in 2015. Just half a percent of that amount, paid in management fees, would be about 1.8 percent of the U.S.’s entire gross domestic product. If opaque wealth-management fees raise the price of finance by 0.5 percent of assets per year, it would account for a
quarter of the entire output of the financial industry.
This implies that we need full price transparency in the financial industry. A simple way to accomplish this would be a law stating that all investors must receive a yearly invoice telling them how many dollars they paid in fees that year, including fund expenses, adviser fees and everything else. Mandatory dollar invoicing would take a hideously complex problem and turn it into a simple one. It would make the financial industry function more like the idealized free market that Hayek and other economists have dreamed of. There’s a good chance it would help investors get more for their money. And it could also help ease concerns that finance is taking up too much of the U.S. economy.
Noah Smith is a Bloomberg View columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at