Valuation-Informed Indexing #60: We Need Higher Commissions on Non-Stock Investment Classes

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by Rob Bennett

Say that the percentage of your return on a Certificate of Deposit (CD) paid to the bank at which you purchased the CD was to be doubled. Would you consider that good news?

My guess is that your first reaction is that this would be very bad news indeed. The CD would pay the same return. You would earn less. The bank would earn more. How could this possibly be a good thing for you?

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I believe it would be a good thing for you.

The people who sell us things respond to incentives. They naturally want to earn as much as possible. When they get paid far more for pushing one asset class than they do for pushing others, that one asset class gets promoted very heavily. The imbalance in the investing “advice” we all hear can over time cause big financial problems for all of us.

The commission paid on stock transactions is higher than the commission paid on CD transactions. That’s one of the reasons why so many investing experts tell us that stocks are always the best asset class for the long run. If the commission paid on CDs was higher than the commission paid on stocks, I am confident that it would be the other way around. You would be hearing from every web site you visited how all the academic research shows that you should invest a tiny percentage of your money in stocks and should be sure always to invest most of it in those wonderful CDs.

We don’t need to go that far. There really is research showing that in ordinary circumstances stocks offer the better long-term value proposition. So we don’t want to slant things in favor of CDs. But we do need to take steps to see that middle-class investors are able to gain access to investing advice a whole big bunch more balanced than what was being pushed on us during the Buy-and-Hold Era. The best way to do that is to alter the financial incentives that apply for those providing the investing advice.

I recall the day when I visited my bank with the intent of putting a good percentage of my retirement money into IBonds. I had performed a regression analysis on the historical stock-return data to determine that the long-term return on stocks purchased at the then-prevailing prices was likely to be a very low number, perhaps even a negative number. I didn’t want my money tied up in an high-risk asset class paying a poor long-term return and IBonds were at the time paying a government-guaranteed return of 3.5 percent real. All I needed was someone to bring me the papers to sign.

It was not a particularly easy task to find such a person.

The first person I asked assured me that there was someone at the bank who could handle that and then disappeared. The second person said he would need to check whether the bank was able to handle that sort of transaction. The third person said that she would need to check something out with a higher-up and that I would need to be a little patient. Could I possibly come back on another day?

No, I told her, it wouldn’t be convenient for me to come back another day. Off she went looking for someone to whom to hand the short straw.

As I waited, I looked at the walls. There were advertisements for stock investing services visible before me in every direction I turned. The desks were cluttered with pretty brochures describing all the wonderful things the back could do for me if only I could be persuaded to put my retirement money in the asset class likely to pay a lower return than IBonds.


Why were all these investing professionals so intent on steering me away from the investment class paying a solid, safe return and toward the asset class paying a risky, poor return? Excuse my cynicism but I have a hunch that it might be that the returns they were going to be earning on my money might have been a slighter bigger consideration in their minds than the return that I was going to be earning on my money.

When you buy stocks, the fellow or gal on the other side of the table makes out nicely. When you buy CDs or IBonds or TIPS, the fellow or gal on the other side of the table is not nearly so pleased with the results of his or her labors.

That’s why there are ten books making the case that it is always a good time to buy stocks and that it is impossible to beat the market and that timing never works for every one reporting accurately and honestly and realistically on the academic research showing that stocks are a good buy at some prices and an absolutely horrible buy at some other prices, just like just about everything else we can obtain for money in this consumer wonderland of ours.

Investment experts do not see themselves as being in business to help us to achieve financial freedom early in life. I am certain that just about all of them would like to see us do that, all else being equal. But all else is not equal in this game. In this game, the commissions go to the experts who sell stocks. So the books saying stocks are always best get pushed hard and the books reporting in a balanced way on what the research says are quickly “forgotten” by the “experts.”

We cannot force the experts in this field to give better investing advice. But we very much need them to start providing it. The financial losses suffered during the Buy-and-Hold years have brought on the second worst economic crisis in U.S. history. And we are still in the early years of this mess. We really need to get serious about the problem.

One thing we need to do is to change the incentives that govern behavior of the experts. When we pay the people offering us investing advice as much to help us buy non-stock asset classes as we pay them to help us buy stocks, I have a funny feeling that they will put a great deal more effort into helping us identify which asset classes make the most sense for us.

The title for Rob Bennett’s review of the book Work Less, Live More is “The Retire Early Movement Grows Up.” His bio is here.

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Rob Bennett’s A Rich Life blog aims to put the “personal” back into “personal finance” - he focuses on the role played by emotion in saving and investing decisions. Rob developed the Passion Saving approach to money management; Passion Savers save not to finance their old-age retirements but to enjoy more freedom and opportunity in their 20s, 30s, 40s, and 50s - because they pursue saving goals over which they feel a more intense personal concern, they are more motivated to save effectively. He also developed the Valuation-Informed Indexing investing strategy, a strategy that combines the most powerful insights of Vanguard Founder John Bogle and Yale Professsor Robert Shiller in a simple approach offering higher returns at greatly diminished risk. Tom Gardner, co-founder of the Motley Fool web site, said of Rob’s work: “The elegant simplicty of his ideas warms the heart and startles the brain.”
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