In Search of Simplicity in Finance
Finance is not the only industry that thrives on complexity, or the illusion of complexity, building on the fallacy that it often equates with sophistication. Anything worthwhile has to be complex. How can something that is sophisticated be simple? There has to be something more than what meets my eyes. In truth, complexity is regularly employed to either obfuscate the underlying simplicity (including creation of a “brand” image), or to intentionally configure products that cannot be understood by the average consumer.
Any intelligent fool can make things bigger, more complex, and more violent. It takes a touch of genius — and a lot of courage — to move in the opposite direction.
E.F. Schumacher, 1911–1977 (often falsely attributed to Albert Einstein)
We strongly believe that it is in the interest (pun intended, especially for compound interest) of the consumer to keep Finance simple. Maybe you have come across this anecdote that there are two groups in society that enjoy the benefits of private bankers? It is the Top 1%, of course, and then the poorest, who might not even have a bank account and are at the mercy of payday lenders. Our objective is financial inclusion for this latter group, and simplicity, the lowest friction and the lowest fees possible for anyone.
Interestingly, for example in investments, these instruments have already existed for a long time. They are called passive investment strategies, i.e. mirroring an index and not paying an expensive fund manager to actively pick stocks. The Vanguard S&P 500 index tracker has an expense ratio of merely 0.03%, that is as close to free as one can wish for. So why is not everyone invested with 100% of their stock portfolio into these funds (ignoring for a moment that at the macro level, there are considerations of market structure and efficiency if that would indeed happen)?
The unfortunate truth is that most of us rate ourselves higher than the average. Here are a couple of examples:
In a survey of faculty at the University of Nebraska–Lincoln, 68% rated themselves in the top 25% for teaching ability, and 94% rated themselves as above average
In a similar survey, 87% of MBA students at Stanford University rated their academic performance as above the median
Illusory superiority has also explained phenomena such as the large amount of stock market trading (as each trader thinks they are the best, and most likely to succeed). Most individual traders do not beat the index, nor do most actively managed funds, investment trusts or hedge funds. In recent news, the University of Colorado Foundation was sued for underperforming the S&P 500 over a decade.
The FinTech revolution is not necessarily helpful in that regard. While dazzling the consumer with compelling user experiences that are head and shoulders above the offering of incumbents, all too often the underlying product is not necessarily in the financial interest of the consumer.
Robinhood, which pioneered commission-free stock trading, have created a gamified trading environment that encourages use of a specific order type that is most valuable in selling the order flow to hedge funds (we will explore this topic further in one of our upcoming podcasts). That is not to mention that Robinhood had several extended system outages during high volatility trading days that left customers unable to access their account. Lastly, the well-documented tragic suicide of a young option trader who understood the financial information presented as having incurred a devastating loss.
A number of robo advisors, which for example create a portfolio suitable to their customers’ individual risk profile, structure such portfolio through the selection of above-mentioned passive index tracker ETFs, while charging 1% for their services. That is the 1% fee to select an ETF with a 0.03% expense ratio — a great business model if you can scale it, but not good for our collective financial health.
Metal credit cards have been all the rage recently. Again, this is not necessarily innovation, rich consumers have craved differentiation through status symbols like a carbon credit card for ages, and have been surprisingly will to pay for it. However, in the spirit of “KISS” — keep it simple, stupid! — at the end of the day, even the metal/carbon/gold credit cards all perform the same basic function.
Of course, there are also exciting new business models evolving that are either truly innovative, or bring back business models from the past that failed at some point, but can be realized efficiently with modern technology. Maybe surprisingly, quite a few of them come out of the InsurTech space, whether it concerns the creation of transparency around insurance policy coverage, the re-mutualization of insurance, or life-time income solutions challenging the annuity industry.
Finance should be simple. Complexity obfuscates. At the end of the day, it is just money, and the simpler and more effective the handling of it, the more time we have to spend on the things that and with the people who truly matter to us. Hence, in our next article, we will introduce a simple model of “jobs to be done” in Finance. Until then, please stay healthy and in good spirits!