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How the Internet and Creative Destruction Made High-Net-Worth Investing More Difficult

By: Ryan Fulmer
Thursday, March 1, 2012

It used to be much easier.  Decades ago brokers acted as intermediaries to facilitate stock and bond transactions for clients.  Nowadays, many new approaches to investing keep popping up, although the differences may seem negligible.  Why has this industry changed so dramatically and, more importantly, how do you, as a high-net-worth individual, navigate all of the options?

How the Internet and creative destruction changed the brokerage industry

In 1942, Joseph Schumpeter wrote Capitalism, Socialism and Democracy, which introduced what would become one of the tenets of economics--Creative Destruction.  A great example of creative destruction is Wal-Mart.  They used technology to create new inventory-management systems and personnel-management techniques in order to charge lower prices than competitors.  As a result of this new, innovative approach, the company benefitted from significant growth and abnormally-large profits.  However, as in life, nothing lasts forever, and over time, new competitors sprouted that were mimicking Wal-Mart’s model, thus gradually reducing the outsized returns the country’s largest retailer once earned.

Technology and the Internet have also been destructive to many traditional businesses, causing a revolution in how consumers purchase music, books, and movies.  Similarly, changes have also occurred in the investment industry, as the Internet facilitates instantaneous news and makes the ability to purchase and sell stocks and bonds much easier.  In fact, you can trade Apple stock on your Apple iPad!  Creative destruction has impacted the brokerage industry as well, as the Internet enables transactions in the stock and bond market at a significantly-reduced cost compared to that of a traditional broker.  As a result of discount brokers and the ease with which trading can be completed, commissions have dropped, and brokers have been left trying to figure out how to replace lost revenue.

Adapt or die--How brokers adapted to commoditization of commissions

The brokerage industry has adapted to the “new normal” in a number of different ways.  One prevalent change has been with the creation of the financial planner--a hybrid between traditional brokers and an insurance salesman.  Oftentimes, these professionals sell mutual funds, insurance, and traditional brokerage services.  Another path has been for brokers to change their compensation structure from receiving commissions on each trade to a wrap “one fee inclusive” program; a wrap program’s fee includes trading commissions and the expenses related to the investment solution a broker recommends.  The solution might be mutual funds or could have the client’s assets managed by an investment manager in the brokers tool kit, who then manages the assets as a separately-managed account.  While we encourage investors to manage their assets in separately managed accounts, the layering of fees in wrap accounts can have a large impact on performance over time.  As a result, we suggest investors periodically review the wrap fees they pay their broker for these bundled services.

Do-it-yourself investing--Are you your own worst enemy?

One of the more obvious outcomes of the Internet revolution has been the creation of online brokerage firms.  In our opinion, the key to building wealth for the long term is buying the stocks of excellent businesses at the right price and hanging on to them--even when times are tough.  There has been ample academic research that supports the view that when individuals manage their own portfolio, returns suffer.  Barrons [1] recently published an article entitled “The Money Paradox,” in which they discuss the impact of emotions on investment performance.  The results are surprising, as the research in the article found that 85% of the sale or exchange decisions were wrong, which means the  investor would have done better by doing nothing or making the opposite trading decision. 

Furthermore, the article cites that, in the 20 years ended 2008, the typical stock-fund investor averaged a return of only 1.9% per year, compared to the average return of the stock market of 8.4%.  Do-it-yourself investors too often “sell low and buy high.” The conclusions in this article are not unique and are supported by many different studies and underscore the fact that D-I-Y investors need to be very careful.

Go straight to the source--Why separately-managed accounts at Beese Fulmer are the most prudent strategy for building and preserving your wealth

In this article I’ve discussed a number of different investment options, which can be appropriate choices depending on the individual and at what stage they are in their wealth accumulation.  However, we believe separately-managed accounts at Beese Fulmer have many advantages, making it the best solution for high-net-worth individuals.  When a high-net-worth individual chooses to have Beese Fulmer manage their account, we are able to manage the portfolio in a tax-efficient manner.  When an individual chooses to invest in mutual funds and exchange-traded funds (ETFs), they lose this ability, which can severely impact long-term performance.  (For more on this topic, please refer to our article entitled The Hidden Impact of Taxes on Mutual Funds and ETFs.”)  Clients of Beese Fulmer also benefit from our time-tested rational approach towards investment management.  Our comprehensive strategy includes working with your accountant and estate attorney to maximize the impact of their planning strategies.  Our customized and comprehensive reporting allows the client to see a complete snap-shot of their wealth every month.  When this unique perspective is combined with our investment philosophy, we believe we can build the best portfolio in order to meet your investment goals and objectives.

 [1]www.Barrons.com, “The Money Paradox”.  12/31/2011

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