The many failures of the personal finance industry

A couple of weeks ago Robert Seawright at the Above the Market blog asked an Edge-style question of a bunch of investment bloggers. He asked what should we as investors truly be worried about. He received a number of responses including those from Tom Brakke, Doug Short, Jason Zweig and more, including including myself.

In light of the news that Americans are saving far too little for retirement and 401(k)s are a disaster it was worth re-running my post on the topic on the financial services industry and its role in helping savers reach their goals. Thanks to Bob for letting me re-run the piece.

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What should we be worried about? In terms of existential threats, there are no shortage of things we can worry about. As Martin Rees writes in his response to the Edge question there are a “cluster of risks with low probability but catastrophic consequences” with which we should be concerned. We were reminded in vivid detail last week of the kind of threats we are going to have to deal with over time.

Let’s leave these interesting, albeit existential discussions to those with more knowledge and focus this discussion is on finance and economics. There is a war on savers going on and it is not the one we commonly discuss. While ultra-low interest rates have dramatically changed the calculus for investors something else is going on that has little to do with Fed policy. The vast majority of American investors, or should I say savers, are being left to their own devices with not altogether satisfactory results.

One could argue that the financial services industry, and the political system that helped design it, is in very fundamental ways failing the average investor. In some very important ways there has never been a better time to be an individual investor. For those with the motivation and time to manage their own financial affairs there is a wider array of financial products and services that make investing more manageable. In short, the 1% (or so) are doing just fine.

As I argue in my book this class of investors is exception. The vast majority of Americans have little interest in the challenge of managing their own investments. However society is now forcing this very adult responsibility onto nearly every one. The rise of the defined contribution plan has pushed aside the defined benefit plan for the most workers.

Helaine Olen in her book Pound Foolish: Exposing the Dark Side of the Personal Finance Industry notes how this situation came to be. You can see her speak with Jon Stewart in an extended interview about this and more on The Daily Show. Out of this change came a sea change in how Americans were left to deal with their finances. For awhile it worked out well. The 1980s and 90s were a great time to be an investors whether it be in stocks or bonds. However times, not surprisingly, have changed.

The problem is that it has left us with a financial services industry that is for the most part working against the interests of the investors it is supposed to serve. Barry Ritholtz at the Big Picture notes how the incentives of the financial services industry, almost by definition, lead to compromised products that work against investors. Nor should we expect this to change anytime soon. If a financial crisis and near-global depression didn’t change the system as we know it, what will?

Then again, we investors are likely part of the problem. Carl Richards writing at the Bucks Blog notes how we oftentimes recoil against simple solutions. If there is any hope for the vast majority of investors it almost has to come in the form of easily defined and easily followed advice. By and large we and the financial services industry work against these impulses.

Nor should we look to the financial markets to bail us out. It is now common knowledge that the returns on “safe assets” is almost guaranteed to lead to negative, real after-tax returns over the foreseeable future. The expected real returns on a 60/40 balanced portfolio are at levels not seen since the beginning of the 21st century and we know how that turned out.

That is not to say there isn’t any hope. As it is in most fields the potential for technology to change how we consume and how we save. On the consumption side the rise of “collaborative consumption” allows for the ability to stretch our consumption in unique ways by severing the link between ownership and experience. It is easy to dismiss this nascent trend but if taken to its logical conclusion it could greatly enhance our living standards.

On the saving and investing side technology is making it easier to track where our funds go and how we invest them. The rise of things like peer-to-peer lending and crowdfunding open up possibilities that are by and large outside the reach of the mainstream financial services companies. It goes without saying that these offshoots come with their own risks but they represent how change can occur over time. While many in the investing community resist it I still believe that algorithmic services will help provide investors with good enough advice at a fraction of the cost of today’s current investing solutions.

The challenge is that Baby Boomers who have seen the entire financial landscape change before their eyes are now reaching retirement age seemingly unprepared for it. While many in this demographic will suffer the consequences it is also society at-large that will also have to come to terms with these self-induced problems. It would be naive to think that the financial service industry or its overseers in Washington will willingly push for much in the way of constructive change. In the end it may be the case that our financial goals are simply too ambitious and that we need to lower our sights. What is clear is that we as a society have failed and are continuing to fail the average saver.

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