Free Investing is the new Free Checking

Are you paying for checking? You totally don’t need to. 

Most Americans, at least, have access to a free checking account that offers many of the features we closely associate with a traditional investment account: secure storage of and access to money.

It’s not farfetched to ask the same question about an investment account and provide the same answer. Particularly for investors who own index funds (or “closet index” funds with low active shares), it’s becoming increasingly apparent that there is no need to pay significant fees for a diversified portfolio. Vanguard has long offered target date funds that combine their low-cost index offerings, but Charles Schwab’s “Intelligent” portfolios, which do not have associated fees, are a harbinger of what is to come.

I’ve already said that in the fight against algorithmic investment services, financial advisers “had better compete on something other than cost, accuracy, and speed” but haven’t yet taken that analysis further. My colleague Lauren Foster has noted that robo-advisers and financial advisers had better start getting along, but I will state that more strongly.

Charging for Non-Differentiated Investment Products Is About to Get Very Hard.

If you are selling the same thing as everyone else, and that thing is infinitely scalable at minuscule marginal cost — like many equity index funds — there is little reason for someone to pay you for it. A preponderance of services have evolved to combine various low-cost investments into “customized” investment portfolios, but those products have essentially the same characteristics. The algorithms that combine the products are as scalable as the products themselves.

This leads to a competitive dynamic that is easy to name but difficult to survive: a race to the bottom. Vanguard’s ownership framework, which is not designed to earn a profit, seems to be structured in anticipation of this competitive dynamic.

There is not going to be only one firm providing low-cost index funds, but it is difficult to imagine a true need for the hundreds of them that exist now. In 2012, Business Insider did a survey of S&P 500 index funds and found that Vanguard effectively dominated its competition. Businesses attempting to extract excess fee income from either these non-differentiated funds or the construction of a portfolio comprised of them will have a difficult time justifying their existence.

So Are Professional Investment Managers Going Away?

No way. Fortunately for investment professionals, we are not selling buggy whips. As long as there are organizations and individuals with money, there will be a market for figuring out what to do with it. That market is simply evolving, which is why Lauren’s framing of the next step for advisers as “getting on the right side” of the trend is so perceptive.

I have personally never been more bullish on the future of the investment profession, but that doesn’t mean it’s going to look the same. It’s unlikely that there will be many highly paid employees doing work that could easily be performed by algorithms in the years to come. Instead, look for small teams of investment professionals to be levered as never before by software. To me, it seems like there will still be ample room to provide products along one of three lines:

  • Personality: A more pleasant interface to money management than is otherwise available. This can take the form of a trusted adviser, but also software that integrates more thoughtfully into your daily life. I imagine that many investors would pay for value-added services, particularly for things like life coaching bundled alongside financial advice.
  • Performance: Pure alpha. Simple enough — there has always been a market for outstanding investment results and it is hard to imagine that changing. It will likely become more difficult for “closet indexers,” who are in essence pretending to provide active management, to pass by undetected, but many professional investors will probably welcome that development.
  • Permanence: Advice for the wealthy centered on specific issues relating to their legacy. This currently includes considerations like trust and estate planning, but I imagine that it will evolve to encompass a range of products that are not currently widely offered, like charitable plans that rival investment plans in sophistication, diversification, and analytic rigor.

What have I left out? Do you see a vector where financial professionals can offer value above and beyond that provided by low- or no-cost indexing services? Let me know in the comments section. After all, “free checking” has been around for a while, and it would be difficult to argue that the retail banking industry has altogether gone away since then.

This was written for the CFA Institute and originally posted on the Enterprising Investor