If we consider financial service fees as a “tax” on the earning power of our money, millions of savers are now paying at a rate of 90 percent. Some are paying more. This means the financial services industry can take 90 percent, or more, of every dime earned in interest and dividends.
The people who pay this tax are not the richest Americans.
It wasn’t always this way. Back in 1985, for instance, a 50/50 portfolio of S&P 500 stocks and 5-year Treasury obligations provided a yield of 7.19 percent. Back then, stocks were yielding a healthy 4.25 percent, while 5-year Treasuries were yielding 10.12 percent. So if you paid 2 percent to have your money managed, whether through mutual funds or variable annuities, the financial services “tax” on your income was a relatively modest 27.8 percent. If you were among the fortunate who paid 1 percent for the same service, the “tax” was less than 14 percent of your investment income.
But that was then.
Over the last 24 years, yields on all investments have gone in one direction--- down. Some financial services fees have declined, but they have declined far less than the yield on our investments. The Vanguard 500 Index fund, always a pricing leader, had expenses of 0.16 percent in 1985 and costs 0.16 percent today, according to the Morningstar database. Fidelity Magellan cost 1.12 percent in 1985 but costs only 0.72 percent today. The American Funds Income Fund of America cost 0.66 percent in 1985 but is less today at 0.55 percent.
Typical variable annuity products, on the other hand, still cost about 2 percent a year. Many contracts today cost a good deal more due to the addition of living benefit options.
Today, the same investor who enjoyed a yield of 7.19 percent on a 50/50 portfolio will eke out a 2.25 percent yield. The yield could be pushed about 0.25 percent higher, to 2.50 percent, by using 10-year Treasury obligations, but other options involve some amount of credit risk. Either way, investors in insurance products are basically losing every dime of interest and dividend income to pay fees. Investors in expensive mutual funds are doing the same.
So while our friends in Washington are talking about raising the highest income tax rate to about 46 percent, a great many of our purported friends in financial services are already “taxing” our savings at rates the wealthiest taxpayers may eventually pay--- or still higher.
OK, I see a few “Yes, but” questions out there:
- Yes, but financial services are different from government, right? We actually get something for our money from financial services, right? Answer: Sure. Just look around. And note that the financial cast hasn’t changed very much either, audacity of hope notwithstanding. To be sure, I’m painting with a too-broad brush here, but it will be a long, long time before we recover from what the financial services industry, as a whole, has done for us.
- Yes, but there is more to returns on our savings than dividends and interest, isn’t there? Answer: Yes, there is. Investments can also appreciate in value. That doesn’t happen too much with CDs and short-term Treasury investments, but it has been known to happen in long-term bonds and vast numbers of people regularly pray for capital gains in their stocks.
So to argue that financial services take 90 percent of the return isn’t really accurate because it ignores price gains.
The best part of an investment, however, is its income--- its dividends or interest. They are what you can (almost) count on. They are what you can spend without consequences. Appreciation is uncertain. And if you have to sell to pay your bills in retirement, for college educations, or whatever, a bit of price depreciation can really hurt.
We savers get to live on the appreciation we hope for. The financial services industry gets to live on the bread and butter of our savings, dividends and interest.
This doesn’t seem quite right to me. It’s a bit like the old divorce joke--- the financial services got the mine, we got the shaft.
The Rising “Tax” on Investment Income
This table shows the yield on a 50/50 portfolio composed of 50 percent S&P 500 index and 50 percent 5-year Treasury obligations. It then shows the percent of total yield absorbed by a 2 percentage point management expense.
|Year||50/50 Portfolio Yield||2 percent fee as Percent Tax on Portfolio yield|
|Sources: Economic Indicators, author calculations|