Former Federal Reserve Board Chairman Paul Volcker’s remark that the ATM represents the height of financial innovation in recent decades is mostly right. I would add broad-based index funds and online banking to the list. But Volcker’s deep distrust of financial engineering is spot-on. I thought about his dismissive comment after reading a recent news article and research report.
The Wall Street Journal recently ran a terrific story about universal life. The product was hot in the 1980s and 1990s. Interest rates were high. Life insurance companies were losing business to the “buy term life and invest the difference” mantra. One response was universal life. In essence, the product coupled term life with a savings account designed to help pay for future premiums and keep premiums level as policyholders aged.
Problem is, interest rates came down. People are also living longer. The combination means policyholders in their 80s and 90s are receiving unexpectedly high life-insurance bills to keep their policies current. Some retirees are dropping a policy they paid into for decades.
A research report by the Pew Charitable Trusts on public pension plans found that 11 percent of plan portfolios in 2006 were allocated to alternative investments such as hedge funds and private equity. That allocation more than doubled to 26 percent by 2016. The shift toward more complex investment vehicles helped push up investment fees.
The personal-finance lesson from these stories is that simplicity with money pays. Complex financial products come with risks difficult to understand, and many charge high fees.
We are asked to take more responsibility for household finances these days. The classic example is the 401(k) replacing defined-benefit pension plans. With traditional pensions, the employer bears the investment risk. With 401(k)s, the risk lands on the employee.
Surveys show that most people are busy and have a poor grasp of basic finance. Investing in low-fee, relatively simple financial products is smart for the typical saver with a busy life. For example, buy term life rather than variable universal life; favor immediate annuities over variable annuities; embrace low-fee broad-based index funds and target-date funds for retirement savings; and, if you are nervous about the stock market, put more money into cash rather than invest in fancy derivative-laden black swan funds. Keep it simple.
Chris Farrell is senior economics contributor for “Marketplace” and commentator for Minnesota Public Radio.