The Truth About the Economics of Investment Help

It seems to me I have already cleverly mocked the Wall Street Journal’s Wealth Report blog. I think I said something about how the author doesn’t actually talk to wealthy people so much as talk to people who talk to wealthy Mansion - William Helsen people, or at least talk to those who claim to talk to wealthy people. Then again, maybe that was the Times’ Wealth Matters blog. It’s all a blur to me now.

The latest installment of the Wealth Report doesn’t merely talk to people who claim to talk to rich people, it rehashes an article on Reuters whose author talked to people who claim to talk to rich people.

The post, a little confusingly entitled "Do Millionaire Investors Get Better Deals?", is about how financial firms are now more interested in the investment business of sub-millionaires. This is a change from a few years ago when, we are told, they concentrated their efforts on bigger game.

Further, this trend is not because, as you might suspect, times are tough and these banks and brokerages are desperate for any business they can get. Nor is it because there are, ahem, a lot more sub-millionaires around now than there were a few years ago. (Old joke: What’s the easiest way to make a small fortune on Wall Street? Start with a large one.)

No, only a mean-spirited cynic would think that this new appreciation for the mere affluent is based on either bad times at financial firms or a shortage of the truly rich. It turns out that it is based on the sudden revelation that the working stiffs with only a few hundred grand are, after all, more profitable.

As Wealth Report tells us

A Reuters article quotes Enrique Marazuela, chief investment officer at the fund management arm of Spain’s BBVA, saying that serving clients of lesser wealth is actually more profitable than serving the ultrawealthy.

Customers with 100,000 euros to 300,000 to invest ($147,180 to $441,540) were “much more profitable” and generated business with gross margins of more than 1% of assets under management, he said. For customers with more than two million euros to invest, the gross profit margin was “below 1%,” he said.

If this idiocy doesn’t draw at least a snicker from you, let me phrase it as a word problem. Bob the broker has room to take on one more client. He can choose between Mary Millionaire with $2,000,000 to invest, who will generate 0.50% in annual fees, and Sam Shmoe, who has only $200,000 but will happily pay 1.5% in fees. Which client should Bob accept?

The Wealth Report uses the Reuters story to riff on how folks with more money to invest get better deals, which is true, but completely misses the reason why. It is not because they are more sophisticated shoppers for investment help, nor because the competition for their business is so stiff. It is because as a percentage of assets it is so much cheaper to provide them help.

One of the basic truths of the investment business, so basic it is hardly mentioned by those in the field because it is so baldly obvious, is that it takes roughly the same amount of effort to help each client, regardless of how much money they have. Of course, taken literally this isn’t true, a $10 million client expects more hand-holding and general sucking-up than a $100,000 client, but relative to the 100 to 1 ratio in assets the difference in effort is approximately zero.

On the other side, the value provided to the client, sucking-up excluded, is directly proportional to the assets involved. A good advisor might add, say, 1% in additional returns a year. So it makes perfect sense to the client to think of the fees paid as a percentage of assets rather than a flat dollar amount.

The result is one of the great mismatches of cost and value added in the business world. Giving investment advice to high net worth clients is wildly profitable. Helping out the mere affluent is a tough low-margin business. And giving customized advice to everybody else, i.e. actually talking to them rather than writing a book or hosting a radio show, is impossible.

Yes, the seriously rich get what may appear to be a discount on what they pay in fees as a percentage of assets, but that doesn’t mean they are less profitable clients.

It seems to me that this basic fact of life about investing, and it applies to brokers, investment managers, financial planners, and money advisors of all kinds, is not pointed out often enough.

People often ask how they can find a good investment advisor. The ugly truth is that it depends on how much money you have to invest. If you have more than a million, it’s not too hard. But if you have less than $100,000 it is basically impossible because you won’t generate enough in fees to pay for useful help. And of course that under $100,000 group includes many, if not the majority of Americans. They are on their own.

[Photo: William Helsen]

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