The 80 year-old woman seated across the table from me came from one of the city's finest old money families. She and her husband had been raised in Little Rock during an age where World Wars were numbered. They'd seen the tough times when President Eisenhower ordered federal troops into Little Rock to enforce de-segregation at Central High. But they'd also seen the entire state celebrate young Governor Clinton's move to the White House. Together they'd watched the city grow, living on land her husband had developed into a community of beautiful homes overlooking Arkansas River.
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But her husband was gone, now. He'd died a few months before, quickly but not without warning. He'd had time to arrange his financial affairs, and as she sat before me she pondered his last words to her. "Be prudent," he'd said. She wondered if her money would last. We assured her that the money they'd saved, a liquid portfolio of almost $3 million, was more than enough. Her husband had amassed a fortune. They had developed a lifetime habit of living well within their means. She was going to be just fine. She was one of the lucky ones.
Do you have financial concerns about retirement? Are you lucky enough to have accumulated several million dollars? You don't need that much, but when it comes to the question of "how much?" the answer is usually that "more is better!" What are you doing to follow this wise man's advice? Are you being careful to "be prudent" with your money? Where are you going for help to prepare for your retirement? What kind of life will your spouse have after you are gone? What can you do, now, to prepare? Are you dependent on one of the thousands of advisors working for a big bank or Wall Street brokerage firm? Are they really taking care of you? Are they prudent with your money?
If you can do it, increasing your portfolio's investment return is by far the easiest way to reduce your financial worries about retirement. But how do you get help in this area if investing is not something that comes naturally to you? Many people fall into a trap of either over-paying for traditional advisors, or being reluctant to pay anything they achieve disappointing results following bad, free advice. There is no shortage of people willing to take your money in exchange for helping you manage your savings program (yes, even including authors). Most of these people are honest and hard working professionals doing the best job they can for you. But most "financial consultants" are salesmen first and foremost. Their companies trained them in how to use pre-approach letters, cold calls and seminars to generate leads. They are not handed a book called Classics: an investors’ anthology and told to study it so that they will learn how to make money for their clients. They study, and are paid for, their ability to sell you an intangible product called financial services.
The longer I’m in business for myself, the more I realize that sales is an honorable profession. However, do you want to put a salesman in charge of your financial future?
The world is not static. It is dynamic; it changes constantly. What may have been the best alternative, yesterday, is not always still the best choice today.
- What is a mutual fund supermarket?
A supermarket (soo-pur-mar'kit) is a large self-service retail bazaar that sells food and household goods and, thanks to Schwab's innovation, now mutual funds. Granted, the mutual funds aren't found next to the carrots and tomatoes, or even in the general merchandise aisle. But the large selection, oriented toward self-service end-users (i.e. retail buyers) is the same. The market owner receives a small percentage of each sale and like in a traditional supermarket the vendors pay the supermarket to get their products merchandised on store shelves.
John McGonigle was one of the people at Charles Schwab who led the effort to develop the new supermarket of mutual funds. McGonigle believes the true financial innovation occurred in 1984 when Schwab's Mutual Fund Marketplace was invented. Prior to that time most of the industry assumed that a central marketplace for mutual funds wouldn't have been legal. The Investment Advisor Act of 1940 prohibits the sale of mutual funds at anything other than the offering price in the prospectus. The industry read this as a prohibition of any transaction fees levied in conjunction with the purchase or sale of mutual funds.
In late 1983, however, Charles Schwab sought and received a ruling from the SEC which permitted them to charge transaction fees for managing the purchase and sale of mutual funds. Even after resolving the legal obstacles, however, Schwab had to overcome the formidable technological hurdle associated with developing electronic links with the fund companies and developing the operating capabilities required to implement the Mutual Fund Marketplace.
For Schwab, however, the push to develop a Mutual Fund Marketplace has always come from the top. Charles Schwab and other senior executives of the firm, mutual fund investors themselves, were saying, "I hate getting all of these statements! Let's develop a marketplace which creates an exchange where these funds can be traded." Charles Schwab, the discount brokerage firm's founder, said, "I'm an investor. I'm in the business. Here's something our firm can do to make this work better."
Rich Arnold led Schwab through a 1987 management buyout from BankAmerica. In early 1989, about two months before Arnold retired, McGonigle joined Schwab and
Arnold told him, "We've got this little jewel called the OneSource marketplace." At that time, there was less than $1 billion invested in the Mutual Fund Marketplace. Schwab's product was in an awkward market position at the time. Because Schwab was forced to charge a transaction fee on all no-load mutual fund purchases, the nation's largest and most aggressive discounter was, ironically, the most expensive place to buy a no-load fund. Moreover, they were selling this service to Schwab's notoriously fee-conscious clients. But Rich Arnold knew that as industries mature, the manufacturing sector becomes more of a commodity and distribution becomes more important. Consequently, as industries mature, profits shift toward distributors. He knew that Schwab was perfectly positioned to become the world's more significant purveyor of mutual funds. In early 1990, Schwab asked the Boston Consulting Group to help the company figure out how to keep growing in the 1990's. John McGonigle was one of four people from Schwab given an opportunity to work on that effort. The BCG study concluded that to keep growing in the 1990's, Schwab was going to have to get its mutual fund act together. Direct stock ownership was being replaced by mutual fund ownership. Schwab had pioneered the concept of a mutual fund marketplace, but it would still have to act quickly to get in front of the curve. The BCG study created a lot of passion at Schwab to get going. Others at the firm began to realize how important the Mutual Fund Marketplace was to the firm's future growth. The study confirmed that demographics favored further growth in the investment industry, and that the trend toward mutual funds replacing individual stocks would be long-lived. BCG also concluded that industry economics dramatically favored firms which could take advantage of economies of scale. The study helped build a case for change, but the development of the no-transaction fee fund supermarket required additional study.
Price below cost and make it up on volume?
At the outset, the economics of the Mutual Fund Marketplace were not obviously attractive. In the early 1990's, Schwab's clients had invested a little more than $1 billion through its Mutual Fund Marketplace funds. Total transaction revenue divided by total fund assets indicated that it was a 60 basis point business at the time. (In other words, total revenues equaled about 0.6% of assets under management.) Instead, McGonigle and other proponents of the new OneSource supermarket were suggesting to Schwab's prestigious and powerful Management Committee that Schwab trade in its 60 basis point gross margin for a 25 basis point margin, and make up the difference in the higher volume that the price cut would foster. Instead of charging customers transaction fees to cover costs which equaled 0.60% of assets under management, the new product would charge the fund companies the equivalent of 0.25% of assets under management (investors would pay nothing).
At first glance, it appeared that the OneSource proponents were willing to give away more than half of the firm's existing revenues. McGonigle and others argued that the popularity of the product would attract so much additional money that the firm's fixed costs could still be covered, even at the drastically lower gross margin. The OneSource camp developed a financial model which showed that the current 60 basis point revenue stream was contracting. Whether the Management Committee liked it or not, they argued, the gross margin was headed lower. The 60 basis points was not a sustainable long-term margin.
No matter how logical these arguements seemed, McGonigle was still faced with the daunting task of quantifying the model and proving his argument with the numbers. He worked with Barbara Heinrick, then head of mutual fund marketing for Schwab, to develop these all important projections. Racing between meetings in Washington D.C. taxicab while attending a busy Investment Company Institute (ICI) conference in May, 1992, they estimated how many customers they'd have, how many funds each customer would use, and how much money would flow into these funds.
These guesstimates formed the basis for the formal asset growth and total revenue projections used in the financial model's five-year plan. Even going into the final Management Committee meeting, it was not clear which camp would win. Not until Charles Schwab spoke would McGonigle know that he and Heinrick had been successful.
The firm's dynamic Chairman paused a moment, considering what he'd heard and the details that McGonigle had presented on how they expected to roll out this new program. Finally, with everyone in the room straining to hear, he asked, "Why is it going to take you guys so long to make this happen?"
Next post: Change Doesn't Come Easily
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