Weapons of Mass Deception: How Does FMI Make Money Out of Your Money?
The financial industry is huge, complex, and often impenetrable. The world of finance can be extremely intimidating, thus makes you feel incapable of making money on your own. That’s the time when you realize you need help.
If you ever invested your money into stocks, bonds, or mutual funds, that means you have entrusted your money to the Fund Management Industry or FMI. You are met with slick marketing by these moneymaking industries and decided to put a large amount of your savings into a managed fund. Then you walked out of that room as if you made the best decision of your life.
Investing is actually pretty simple. It means putting your money to work for you. Essentially, it’s a different way to think about how to make money. But why do others make it so complicated? Because it has become a billion dollar business for some institutions.
In a four-part series by BBC, David Grossman investigates how we as savers, investors, and consumers pay the salaries and bonuses of bankers and investment managers and asks whether they’re worth it. The investment industry is a huge business and they are creating massive amounts of money. But where does this money come from? Well, we can assume that it comes from the pockets of savers, small investors, pensioners, and taxpayers among others.
Not a middleman, but a full rugby team
Because you are not directly trading stocks, options, currency, or securities; you need the help of a broker. Depending on your investment platform providers, the steps of getting into a position are 16, or more. With each step, there is a hidden fee, commission, or an administrative fee. And it’s not just one middleman; they are a full rugby team you need to “hire” to take care of your money. These intermediaries would take you to a new level of investment and probably take you out of debt, help you get your dream house, and enjoy an early retirement. Or maybe not. Welcome to the world of investment!
How do they make money? Here are simplified steps:
- Your financial advisor recommends a fund (an investment matched to your equity and the amount of risk you want to take).
- He does this using a platform that takes a cut (you need a platform to have an account).
- The platform informs the fund manager (an independent person who’s supposed to help you manage your funds).
- The money is drawn down to a custody bank that charges a fee.
- The fund manager charges an annual management charge, which is a percentage of your investment.
- He informs a broker to execute the trades who charges a fee for each trade (sometimes, broker charges an annual fee on top of that).
- The fund manager needs research done, and so a fee is paid to an investment advisor to provide research.
- The fund manager might charge a performance fee as well, as an additional bonus for beating a benchmark.
Expectations vs. actual returns
Repeatedly, investigation shows that there’s a mismatch between expectations generated by marketing and actual returns. This has misled many investors into confusion and disappointments. Other demands transparency with their accounts but there are very few firms that offer that. One marketing person shared, “It’s very uncomfortable when we propose these products and portfolios to consumers… The things that they are promising… these products can’t produce.” Asked why there’s no transparency, he said, “The fees are so high in so many overlapping ways.” Thus explains complexity.
A dirty secret of the industry is that active funds (actively managed by an individual manager, co-managers, or a team of managers) get beaten almost every time by passive or index funds (passively managed, it’s like investing on autopilot). Why do passive funds outperform active funds? Aside from very high fees active fund managers are charging, there’s human error they fail to admit.
Fund managers have a tendency to bank profits early
Yes. It’s proven. Investment data expert Rick Di Mascio and his team examined 700 portfolios with 500 billion dollars worth of assets. They examined all of it, share-by-share, deal-by-deal. They found out that fund managers rarely admit their mistakes, which include banking profits too early and holding on to falling stocks in the hope that they might bounce back.
The marketing of a fund
But how do these professionals get away with the mistakes they fail to admit? The secret is in slick marketing. Numbers don’t lie, you might say. The “guaranteed results” they promise and the “proven track record” for the last ten years they showed you must be something. But remember, in investmestment, anything that’s too good to be true ain’t true. You might want to consider this: they close funds that don’t do well or they stop marketing them. True story.
They will often show you how a fund performed in 10 years but you will never see how much the end investor made after the fees and commission. To estimate the actual charges in a fund, this site provides a calculator:
How does the fund management industry really work?
A simple model would be to think of a big port where ships load and unload cargo from all around the world. In banking, they are buying and selling the same assets electronically to each other. The thousands of bankers in this imaginary port make money each time a transaction takes place.
The important job every asset management industry needs to give to customers are: (1) to help them build resilience to financial adversity, (2) achieve financial goal, and (3) enjoy a decent standard of living and retirement. And lastly, they should offer transparency at no extra cost. They take the money you work hard for. You deserve to know what’s going on.
Disclaimer: The information in this article does not constitute investment advice. You should always seek independent advice before making an investment decision. This article is only intended to generate a discussion.