23 October 2011

How Much Does Financial Expertise Cost?

Saying that financial literacy is important is one thing. Almost everyone has heard it. Now it comes to the cost of reasonably good financial expertise. This is a completely other story (be wary of those who use the word “financial literacy”, but mean something else). You may think that financial knowledge is available for free or for a very little cost: there is Google and a lot of good stuff in internet after all. But hold on, even if you are doing your own research, it’s your time that costs. According to my assessment, when we add up the costs for all the financial expertise that we need in our personal and professional lives, even a pretty average guy needs to spend an amount starting from USD 10,000 per annum to access sufficient amount of reliable information (or what you believe is reliable enough even if it’s not the case in reality).

Case no. 1: Doing my own research

To make an example of myself: this is the case of doing nearly 100% my own research (because I’m a financial blogger and analyst by myself, right?). In addition to the following calculations of recurrent costs, I have made a nice upfront investment into my financial education (starting from studying finance at the university; you may be able to skip much of this, only I did not know it at the time).

It takes me minimum four hours per week to keep up with the relevant news (mainly what concerns macroeconomic developments and the financial sector, because these are my focus areas). Additional three hours each week I’m spending for browsing through my favourite financial blogs, for reading some new financial regulation or analyses by the IMF or the European Commission or rating agencies, for finding out the answers to some specific questions that I may have concerning some shareholding etc. That’s seven hours per week, 364 (7*52) hours per annum. Then there is all the data gathering work from the statistical bureaus, from the banks’ financial reports, market prices etc. This is quite a time consuming part, even if I have already figured out from where I get what information. Let’s say 160 hours per annum (it feels more like an underestimation; I should start measuring the time spent for this more precisely). In total: at least 524 hours per annum to gather enough information just for the feeling that I more-less understand what is going on, and am able to make adequate financial decisions what concerns my very own finances.

Let’s say my alternative cost currently is EUR 30 per hour (rather realistic pay for an expert in a specific area, not certainly finance). So even if I would spend zero for conferences, seminars, books, trainings and professional networking (which is not true), my annual spending to the financial expertise would still be EUR 15,720 per annum.

Case no. 2: Using advisory and asset management services

It were a terrible waste of human resources, if everyone would spend 500 or more hours per annum just for gathering the financial and economic information that he or she needs for the sensible financial decisions. Beside finance, there are too many other (more) important professions. So instead of doing one’s own research, at least in theory using financial advisory and asset management services might make sense. (In practice, reliability of advisory services is always a question; especially, if there are conflicts of interest – and too often there are, but ok that’s a separate issue.)

Let’s consider a “typical” client of the financial planners: a couple in the age of 50-59 years, with the annual income of USD 100,000-150,000, and with the net worth between USD 1,000,000 and USD 1,500,000 (2011 survey of trends by the College for Financial Planning). Apparently, this couple is most considerate about the health care costs and the retirement funding (because of the Ponzi scheme of social security, volatile financial markets and uncertain economic outlooks). How much are they spending for the financial expertise?

There are various ways to pay for the advisory services: an upfront sales charge, a percentage of assets under management, a flat fee or hourly rate. According to the above referred survey, the most common method of earnings for advisors is fee plus commissions (60% of the surveyed financial planners use this method).

Let’s say that the commission fee is 1% of assets under management. So the “typical” client has to pay USD 10,000-15,000 per annum just for this. That’s not all by far: the client still needs to spend time for due diligence, as well as money and time for the other sorts of financial expertise.

Accessing research services of the well-known research firms is not cheaper either. For example, some time ago I received an offer from the Roubini Global Economics where the annual subscriptions started from USD 10,000 (if I’d have wanted a more personal service, the price would have been USD 25,000).

Case no. 3: Using alternative/shortcut solutions

Ok, everyone is not a financial analyst or even interested in this kind of job. And many of the people do not have (or do not yet have) a free USD 10,000 either to pay for the advisory services each year (or do not consider it reasonable). Then there are two options:
1) you do not care and bear the cost of financial ignorance, or
2) you find an alternative/shortcut solution.

Option (2) is interesting because it may happen that you “stumble” upon a “golden egg”. Indeed, there are good professionals that are sharing their specific knowledge in social networks, in blogs and in their own websites. You may find some of them via blog aggregators like Seeking Alpha, for example.

The thing is that most likely you will end up in Case 1, i.e. by spending a lot of time for doing your own research. Only this time you are not searching for some sort of information, but someone who would provide you with the information. There are several points of consideration.

How do you recognise someone who would provide you with the valuable expertise that you need? Often such people even do not have professional designations like CFA or CIIA, or an MBA or something like this. Not agreeing with the mainstream does not automatically mean being an expert. Based on popularity? That’s one option, but “popular” often means “good at marketing” rather than anything else. Read "The 4-Hour Workweek: Escape 9-5, Live Anywhere, and Join the New Rich" by Timothy Ferriss and get know the secrets of getting an “expert” within just a few weeks. Based on how much money they are able to make by themselves? That’s another option, but how can you be sure about their actual assets and liabilities, and if their methods are acceptable for you? Note that you do not have any guarantees. Based on their professional background? That’s the third point to consider, but an investment bank analyst may actually have spent the most of his professional career editing PowerPoint slides.

Too often those who are good experts in one area start commenting on topics which they actually do not know that well. I’m doing it by myself in this very same blog too: I can provide professional insights about the bank stress testing, capital adequacy calculations and things like that, but I do write about other issues. So in fact, following just a few persons is most probably not enough, and at the end you will need to put various pieces of information together by yourself anyway.

Even if you find really good stuff, it is most likely a part of a freemium, i.e. at the beginning you get it free and then, to continue the use of the service and/or use the advanced features or functionalities, you will have to pay.

But, once again, you may be lucky.

Conclusion?

Sure the above examples are far too generic and far too simplified. We even did not discuss the cost of financial ignorance or the value that we get for the above cost. Yet the point is that (if not doing so already) we should start thinking about this question: How much am I actually spending for the financial expertise? (The poll is up right; the currency is USD, because the majority of my readers are from US.)

I believe that these costs can be brought down significantly by reducing the double or triple or quadruple or... (I don’t know how many multiples there should be) analysis and research work that the complexity of financial industry generates.

The bad news is that the financial industry is unlikely to get simpler or even more transparent; rather other way round. This despite of what the consumer protection agencies may say about plain vanilla financial products. Just look at the more and more complex structures that the central banks, governments and international organisations like IMF are proposing for dealing with the troubling banks and sovereigns right now. The other bad news is that there will be no more transparency either (at least not from the regulatory side). And one more bad news: savers will continue losing money, if not in nominal terms than in real terms for sure.

The good news is that although rare to find, there is really good financial expertise available, and for a fairly reasonable price. The other good news is that sorting out good stuff from all the scam and spam may be easier than you think... As noted above, you may be lucky. I’ll come back to this in near future with the aim of increasing the rate “luckiness”.

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