Category Archives: Income Investing

The Future of Retail Banking

Future of Retail BanksUSA Today ran a story in March on the changing nature of retail banking in America.  This sounds kind of boring, perhaps, but it has broad implications both for bank clients and, potentially, for investors.  The gist of the story is that banks are closing retail branches in small towns.  A lack of traditional banking services is not a rural phenomenon, however, with substantial populations of people in urban areas who do not use traditional banks.  For an informative interactive tool that allows you to explore the populations of people lacking key financial services, see here.  There is a substantial population of people who have little or no access to traditional bank services (the under-banked or the un-banked), and it would seem that this population is likely to continue to grow if banks close their smaller retail branches.  The solution, I believe, is that online banking services will serve the under-banked and un-banked, just as they have in the developing world.

In general, poorer households hold little if any assets in savings accounts and primarily use banks to cash checks.  Banks don’t make money from check cashing, so they have a hard time profitably serving these customers.  With interest rates at or near record lows, even bank clients with meaningful levels of savings provide little in the way of income to banks.  And banks, not surprisingly, are focusing on wealthier clients as the way to boost revenues.  The goal is to sell more profitable investing and financial planning services to wealthier clients.  As the large banks try to move up-market in terms of products and services that they offer, it seems likely that an increasing number of less-wealthy Americans are quite likely to have less access to traditional bank services.

What does the future of retail banking look like?  First, it seems inevitable that serving less-wealthy clients in physical branches will continue to be a relatively unattractive business.  Second, check cashing and payday lending businesses—alternatives to traditional banks–will probably continue to grow.  Lisa Servon, a professor of Urban Policy, argues that payday lenders provide a valuable service and that the industry is unfairly demonized.  If people need to borrow money and don’t have access to a traditional bank, a payday loan may be worth the cost.  Third, the increasing role of online banking and bill payment among the middle class reduces the time that customers spend in physical branches.  There are a range of perspectives on the future of retail banking (see here and here).

My belief is that physical retail bank branches will largely disappear.  If you really want or need to go to a physical branch – to access your safety deposit box, for example – you probably don’t mind driving.  Otherwise, what does the retail bank really provide that you cannot get online?  Bank analyst Dick Bove actually makes the case that quality customer service at branch locations is not necessarily even a good sign for investors.  He posits that bank employees generate more revenue for the bank by spending their time “selling products”, rather than by trying to solve problems for customers.

As the systems for mobile banking expand, this could dramatically help the un-banked and under-banked as well as displacing retail banking services for the more affluent.  In the developing world, for example, mobile banking (banking services provided via mobile phone) is already a dominant force.  Businesses can pay their employees via mobile banking, entirely removing the need to cash a physical check.  The M-Pesa mobile payment business now serves seventeen million people in Kenya alone.  Mobile payments were the fastest growing form of payments in China in 2013, totaling $1.6 Trillion.  There are also a host of non-banking firms that are providing services that look like banking. There is no obvious reason that some or all of these types of services cannot expand into the U.S. to serve the un-banked and then move up-market to replace some or all retail banking services to more affluent customers.  The current situation reminds me of a number of cases of technological innovation discussed in The Innovator’s Dilemma, the ground-breaking book by Clayton Christensen.  The book argues that new technologies first succeed not by displacing entrenched providers, but rather by first meeting the needs of an un-served population.  After the new technology has proven its worth, it then moves up-market to disrupt the traditional business model.  The current state of mobile banking is in serving the developing world, where people often have little or no access to traditional banks at all.  The enormous growth in these businesses suggests that the future is to move up the food chain.  Mobile payment technology and usage is growing in the U.S., albeit slower than expected.  Accenture projects that as much of 35% of retail banks’ revenues could be lost to a range of online services providers by 2020.  Given that retail banks in the U.S. are seeing their traditional businesses struggle along with  less use of their branch offices, coupled with a growing population of potential clients who the retail banks do not serve at all, mobile banking looks to me like the future of retail banking.

How Much Do You Need to Save for Retirement?

In the financial advisory business, one of the most pressing and controversial topics is how much money people need to save during their working years in order to provide for long-term retirement income.  The research on this topic has evolved quite a lot in recent years, and a recent issue of Money magazine features a series of articles representing the current view on this critical topic.  These articles, based around interviews with a number of the current thought leaders on this topic, deserve to be widely read and discussed.

The series of articles in Money kicks off with perspectives by Wade Pfau.  Pfau’s introductory piece suggests a difficult future for American workers.  A traditional rule-of-thumb in retirement planning is called the 4% rule.  This rule states that a retiree can plan to draw annual income equal to 4% of the value of her portfolio in the first year of retirement and increase this amount each year to keep up with inflation.  Someone who retires with a $1 Million portfolio could draw $40,000 in income in the first year of retirement and then increase that by 2.5%-3% per year, and have a high level of confidence that the portfolio will last thirty years.  It is assumed that the portfolio is invested in 60%-70% stocks and 30%-40% bonds.  The 4% rule was originally derived based on the long-term historical returns and risks for stocks and bonds.  The problem that Pfau has noted, however, is that both stocks and bonds are fairly expensive today relative to their values over the period of time used to calculate the 4% rule.  For bonds, this means that yields are well below their historical averages and historical yields are a good predictor of the future return from bonds.  The expected return from stocks is partly determined by the average price-to-earnings (P/E) ratio, and the P/E for stocks is currently well-above the long-term historical average.  High P/E tends to predict lower future returns for stocks, and vice versa.  For a detailed discussion of these relationships, see this paper.  In light of current prices of stocks and bonds, Pfau concludes that the 4% rule is far too optimistic and proposes that investors plan for something closer to a 3% draw rate from their portfolios in retirement.  I also explored this topic in an article last year.

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Economic Inequality

Income inequality is increasingly acknowledged as a key economic issue for the world.  The topic is a major theme at Davos this year.  Economic inequality is also an increasingly common topic in U.S. politics.

A new study has found that economic mobility does not appear to have changed appreciably over the past thirty years, even as the wealth gap has grown enormously.   The authors analyzed the probability that a child born into the poorest 20% of households would move into the top 20% of households as an adult.  The numbers have not changed in three decades.

On the other hand, there is clearly a substantial accumulation of wealth at the top of the socioeconomic scale.  The richest 1% of Americans now own 25% of all of the wealth in the U.S.  The share of national income accruing to the richest 1% has doubled since 1980.  In contrast, median household income has shown no gains, adjusted for inflation, since the late 1980’s and has dropped substantially from its previous peak in the late 1990’s.

Why is this happening?

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Review of The Affluent Investor by Phil DeMuth

I have known Phil DeMuth for a number of years and I admire his common sense and views on many topics.  Phil authored the recently-published book The Affluent Investor that fills a need in the crowded shelves of investment books.  As a financial advisor to high-net-worth families, Phil brings valuable perspective to investors who have built substantial portfolios and seek to protect and grow their wealth effectively. Continue reading

One Advisor’s Approach to Income Investing

Guest post by Contributing Editor, John Graves.

Editor’s Note:  John Graves has been an independent financial advisor for 26 years. He is one of the two owners of The Renaissance Group, a Registered Investment Advisor based in Ventura, CA.  John’s book, The 7% Solution: You Can Afford  a Comfortable Retirement, was published in 2012.  When I read this book, I was impressed with John’s approach and thinking and I recommend it as a good read.  I contacted John and asked if he would consider contributing to this blog.  After we bounced around some possible topics, he sent me the following piece that describes his process for designing income plans for retirees.  Continue reading

What Are the Core Asset Classes for Income Portfolios?

In a recent post, I presented a list of the ‘core asset classes’ that investors need in order to build portfolios that fully exploit available diversification opportunities.  That article focused on portfolios designed for total return potential, the combined return from price appreciation and income generated by the assets in the portfolio.  For investors focusing on building income-generating portfolios, the core asset classes are somewhat different.  In this article, I present a proposed set of core asset classes for income-focused investors, along with examples of representative funds.  Continue reading

Investing for Income vs. Total Return

One of the most-discussed issues in long-term investing is whether to focus on income generation or simply to think in term of total return (price gains plus income).  The discussion of this topic often focuses on whether investors should seek out stocks that pay dividends vs. simply planning to sell a fraction of their portfolio periodically to provide income.  I recently wrote a long article on this topic, which has been cited in a very interesting discussion of this theme going on at Bogleheads.    One of the most active participants in the debate on the Bogleheads forum and elsewhere is Larry Swedroe, a well-known advisor and author.  As I read the Bogleheads discussion thread, it strikes me that there is considerable confusion around this topic, so I thought I would add a few more thoughts. Continue reading