I wrote this shortly after arriving in India for a three month international rotation. It's one of the essays that remains most important to me. It was written for CFA Institute and first published on the Enterprising Investor.
Fees are like mosquitoes: They’re everywhere, nobody has anything positive to say about them, and most people don’t know why they exist.
Some in the investment management industry strongly agree and aren’t afraid to talk about it. Over the years, I have seen at least five well-regarded hedge fund managers say something along the lines of, “There are 10,000 hedge funds. Only about 500 are adding value to their clients.”
We also need to look at the fees some of our cousins in the banking industry are assessing with seeming impunity.
I know this because when I did, I found a combination of market failure, moral outrage, and missed opportunity.
Janice is an imaginary friend of mine. She is single, has no kids, and worked a full 40 hours every week in 2016 at a small shop on the Grand Concourse in the Bronx, one of the five boroughs of New York City. Since her employer is a small business, she earned the $9-an-hour minimum wage, $18,720 total for the year.
After deducting taxes and making conservative estimates of what she needs to spend every year on rent, food, health insurance, clothing, and so on, I estimate Janice has about $4,570 a year in “discretionary” income. That’s $380.83 a month.
I won’t talk you through the model because you can inspect it directly, but I have likely significantly overstated her financial flexibility.
For simplicity, I assumed she never dines out, has an emergency, or spends money on entertainment. She will eventually develop scurvy thanks to the diet I used to estimate her food costs. She has also managed to secure an apartment in New York City for $468 a month.
Say whatever you want about my analysis, but I’m not being too tough.
Not Enough Money for a Bank
Well over half — or 57.4% — of unbanked Americans cite not having enough money as the reason they have not opened a bank account, according to the Federal Deposit Insurance Corporation (FDIC). Janice is one of them. This is not without reason.
New York City comptroller, Scott Stringer, has produced a tool intended to help low-income New Yorkers find bank accounts and to estimate the annual cost of holding one. The comptroller’s estimate is reasonable but also quite conservative. It includes one overdraft a year and accounts for the effect of a low, fluctuating balance. I took the data presented there and with the help of a research assistant from Perssist, focused just on those listed banks with branch locations in the Bronx. As above, you can inspect this work directly.
If Janice were to randomly pick a bank in the Bronx, she can expect her account to require $92 per year in cash, 81% of which ($75) will go towards some kind of fee. That is about 1.5% of her “discretionary” income. If she were to walk into the first bank branch she saw on the street, I expect the cost would be substantially higher: $139 a year, 85% ($118) of which will go to some kind of fee. That is about 2.5% of her “discretionary” income.
She is well aware of this figure, and that is why she hasn’t opened a bank account. Unfortunately, she’s not aware of the comprehensive cost of her alternatives.
If you don’t have a bank account in the United States, you might use a check-cashing service and a prepaid debit card instead.
A check-cashing service puts its own capital at risk when clearing a check, so naturally it seeks to earn a return. In New York, the fee the services can charge is capped at 2.01% of the value of the check, but that still means Janice pays a total of $316 a year to access her funds, which is 6.9% of her discretionary income.
This is 31% more than she pays for health insurance, and she’s paying it just to use money she has already earned.
She also has a prepaid debit card for online purchases and for convenience. The Consumer Financial Protection Bureau (CPFB) gave her a small amount of protection after the “catastrophic system failure” of one prepaid card provider drew attention to this fast-growing sector and its customers’ remarkable lack of recourse.
In researching these cards, I learned about fees I had never imagined. There are balance inquiry fees and 32 line fee tables. Of course, not all of the cards function this way, but separating the wheat from the chaff is a Sisyphean task. I have a reasonable claim to financial expertise, yet I am not sure how I would begin to estimate the full costs of some of these services.
Not Just Janice
In the Corporation for Enterprise Development’s (CFED) 2014 estimation, Bronx County is the second-most underbanked county with more than 100,000 residents in the United States. The CFED estimates that 20.8% of its residents do not have a bank account, and 27.2% are “underbanked,” meaning that they have a bank account but still rely on a mix of financial services to fulfill their needs.
Separately, the Urban Institute produced slightly higher estimates in 2015. It pegs the combined percentage of unbanked and underbanked Bronx households at 52.3%. Remember, the Bronx is an 11-mile drive from the New York Stock Exchange.
When I first joined CFA Institute, I contributed to some research on the fees of variable annuities. The highest upfront sales charge permitted on these instruments by the National Association of Securities Dealers (NASD) is 8.5%, but this fee is assessed on investment capital.
Because Janice is subject to such substantial fees before she can even amass investment capital, the possibility that she ever will is reduced. This is no one organization’s fault, but it is wrong.
Lessons from Mumbai
I am doing a rotation in our Mumbai office, and the comparison is striking. India is moving light years ahead of the United States when it comes to providing banking access to the poor, and the country’s example is worth paying attention to.
In August 2014, the government introduced a plan called the Pradhan Mantri Jan-Dhan Yojana (PMJDY, Scheme for People’s Wealth) that provides not just free bank accounts to all citizens, but also free overdraft insurance. In a country where about 17% of the country is Dalit (“Untouchable”) and faces profound discrimination, the government recognizes that a bank account is a pathway to personal autonomy.
Prime Minister Narendra Modi nails it when he refers to the unbanked as financial untouchables. If you think wealth creation is good and want it to happen, freeing the unbanked where you find them is an obvious step.
How long will New York City remain a leading financial center if its own residents can’t obtain decent bank accounts?