“Unbundling” is an interesting word. The first unbundling I ever heard about was the famous Carterfone decision. It forced the unbundling of phones from the original nationwide ATT phone service. After that decision, you could buy your phones from anyone who cared to produce them.
Today we wonder whether we’d like to have our cable TV service unbundled. This would allow us to pay for channels individually rather than in large and expensive bundles.
Now that you’ve got the basic idea of unbundling, let’s see how our money management is bundled. Today, the old-line financial service firms are big on bundles. They still operate on the old “yield to broker” principle. They seek a yield of about two percent a year on our money. Some, usually insurance firms, seek more. Some seek less. But the central deal is that people buy bundled services.
First, you buy financial products that cost at least one percent a year by themselves. Then, to avoid commissions, you pay a “wrap” fee of about one percent to have the personal attention of a financial adviser. That financial adviser, you're told, will also help you with your financial planning.
What a deal! You’ll pay 2 percent a year for your all-in-one financial manager/planner. Wall Street gets all the interest and dividend income your money generates. And you, proud owner of capital, get all the risk.
It works for them.
Now let’s suppose we “unbundle” that package. Let’s see how much we are paying, in dollars, for the one percent wrap fee. Then let’s see how much time it will get us with a Certified Public Accountant. The figures below, based on hourly fees of $100 to $200 an hour for professional time, translate into nice annual salaries.
- An investor with a $100,000 account would have a wrap fee of $1,000 a year (in practice it would be more for an account that size). This would get 5 to 10 hours a year of skilled CPA time.
- A $250,000 investor would have a wrap fee of $2,500 a year and could buy 12.5 to 25 hours of CPA time.
- A $500,000 investor would have a wrap fee of $5,000 a year and could buy 25 to 50 hours of CPA time.
- A $1 million investor would pay $10,000 and could buy 50 to 100 hours of CPA time.
I could go on, but you get the idea. That 1 percent fee buys more time than you need or get. I mean, really, just how complicated are the big financial decisions in the lives of most people? And how much time has to be spent to come up with a reasonable and accurate answer? A lot less than a full 8 hour work day in a year.
Unbundling opens not one, but two, avenues of fee savings.
First, once you step away from the fee-ridden world of the major brokerage houses and insurance companies, you can step away from high active management fees. This can take your asset management expenses down from one percent a year to less than 0.20 percent. At the same time, the change will increase the odds of better performance.
This is already happening. Today, many independent registered investment advisors offer low-cost index fund portfolios.
Second, if you separate asset management from financial planning, you can determine how much financial planning advice you need in any given year. And you can pay for it on an hourly basis rather than committing a huge retainer fee for services you may never use.
Is it easy to do this? Yes and no. The increasing use of life cycle mutual funds in 401(k) plans has introduced millions of retirement savers to the idea of lower cost, one-decision investing. It has done the groundwork for the “robo-advisers.” These are online firms that offer diversified asset management at prices that are hard to resist.
The legacy firms keep pushing back, offering more smoke and mirrors. They insinuate superior skill and performance without a bit of supporting evidence.
They have a good reason for doing this. When they charge 2 percent a year on our money, they earn far more than a good CPA does. And they charge more in one year than it costs to manage a simple low-cost portfolio for a decade.