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On Vanilla Products

Though Congress may not mandate the sale of vanilla financial products to consumers, it is worth thinking about the concept in general. I have written two articles that argued that consumers should only simple products from insurers:

Life Insurance: A Bet You Don’t Want to Win
The Pros and Cons of Buying Annuities

Men (this includes women) are good at analyzing questions of more and less with one variable.  Stick to that, and most men do well.  When there are two or more variables, the rationality breaks down, because the average man does not know how to analyze the pricing tradeoffs.

Term insurance and deferred annuities are relatively simple; the markets are competitive because men can make simple price comparisons across similar products.  That’s why insurers try to sell unique combination products.  The more unique a product is, the harder it is to compare against products that might be cousins.

The same applies to banks.  I don’t believe that any bank should be forced to sell a product, but it would be smart for some banks to market themselves as “basic banks.”  No products are marketed as bundles, every product is sold separately.  Products are sold at cost plus risk-adjusted profit margin.

Some banks could bring in a lot of business if they did this.  I had a similar idea regarding variable annuities, where a life insurance company would charge a mere 40 basis points per year to wrap a variable annuity, with no guarantees.  It would create the generic tax-deferred mutual fund.

In the same way, some backs could win a lot of business offering generic credit cards, simple mortgages, etc.  The only difficulty is getting through gatekeepers, because the average American does not search for the best deal.  Gatekeepers often offer what compensates themselves best.

Aside from complex tax planning reasons, simple products are usually the best.  I encourage my readers to look over the financial services that they use, and aim for simplicity.






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3 Responses to On Vanilla Products

  1. Varada says:

    David,

    Regarding your comment about wrapping a variable annuity for 40bp,it is impractical simply because most of the current charges on a VA wrapper(say 100bp out of 140 bp) goes to the salesman who sold the VA to a customer.That is why VA wrappers are expensive.Selling it for 40bp will require a totally new approach to distribution.

    • Varada, you are right — this is a product to be marketed by the mutual funds themselves. “Sir, would you like the T-class shares? Higher expense charge, but they are tax-deferred. Otherwise the same as the class of shares you would ordinarily buy.” The mutual funds make their money off of their ordinary fee structure, and gain stickier business as a reward.

      Also could be used by no fee financial planners.

  2. Harper Capital says:

    David, doesn’t Vanguard and Fidelity offer a low fee VA product using in house funds? At some point I another low fee insurace offering was out there (under 50bps+fund fees) for no fee planners, but cannot remember the name for the life of me. I think they worked with Rydex to grab traders assets.

    I agree it’s a great way to retain sticky assets.

Disclaimer


David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures.


Also, though David runs Aleph Investments, LLC, this blog is not a part of that business. This blog exists to educate investors, and give something back. It is not intended as advertisement for Aleph Investments; David is not soliciting business through it. When David, or a client of David's has an interest in a security mentioned, full disclosure will be given, as has been past practice for all that David does on the web. Disclosure is the breakfast of champions.


Additionally, David may occasionally write about accounting, actuarial, insurance, and tax topics, but nothing written here, at RealMoney, or anywhere else is meant to be formal "advice" in those areas. Consult a reputable professional in those areas to get personal, tailored advice that meets the specialized needs that David can have no knowledge of.

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