Hijacking Investor’s Economies of Scale

Over the past 50 years the financial services industry has exploded.  Mutual funds have grown astronomically and there is an investment advisor or broker on every corner.  Retirement assets have shifted from being under institutional control of a pension plan to 401(k) vehicles and other defined-contribution plans, putting the control of assets in the hands of individual investors. As a result, fund assets have boomed along with the business of financial advice.

The Investment Company Institute (www.ici.org) reported that at year end 2011 there were $13T invested in mutual funds in the United States, owned by over 52 million American households.  Individual investors continue to rely more and more on mutual funds over directly held stocks and bonds each year. This is especially true for stock investors as net investment in directly held stocks has decreased every calendar year since 2001.

Of the $13 Trillion held by mutual funds, nearly $12 Trillion is invested in actively managed mutual funds. In 1997 there was a total of $4.7 Trillion invested in mutual funds, and over 93% was invested in actively managed funds.

So we see that from 1997 to 2011 the size of the actively managed mutual funds space has grown from just over $4 Trillion to $12 Trillion, a nearly threefold increase.  Yet fund expenses for actively managed funds were 1.04% in 1997 and have only dropped to 0.93% in 2011, barely a 10% reduction.

In fact, equity index funds saw a larger absolute decrease in fund expenses (0.13%) despite starting out with lower expenses to begin with. This 0.13% represents nearly a 50% reduction in fund costs for passive investors.

Of course, mutual fund expenses are only part of the cost of investing for most individuals.  The cost of working with an investment advisor has not declined as a percentage of client portfolios despite dramatic improvements in technology and our clients’ growing wealth.

High net worth investors sacrifice the most of their economies of scale to these two costs:

  • internal mutual fund expenses that have barely decreased in 15 years despite tremendous asset growth; and
  • investment advisory fees that remain around 1% across the industry, with little thought given to whether services offered by advisors are in line with asset-based fees.

The financial services industry in general has absconded with these powerful economies of scale that are rightfully the investors’.


(Much credit due to the Investment Company Institute. You can download the 2012 Factbook here: http://ici.org/pdf/2012_factbook.pdf)

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