Impacts of Investing in the Most Profitable Sector of the S & P – Financial Services

There is an interesting “thought piece” over at the Money.com site that has a number of experts presenting their thoughts on what the future has in store for us. From a purely investment related perspective, and perhaps of most interest to us dividend investing folks is the piece on John C. Bogle about the future of financial services.

In this blog, I have spoken a number of time about the impacts of fees on an investment portfolio. The trouble is, there is very limited awareness of the investing public of the huge fees that are being charged for investment services. Take Canada’s mutual fund industry, which has one of the highest fee structures in the world. Recent profits on one of the Canadian fund companies speaks to this.

Within the article, Bogle makes a comment that over the next 35 years we will see big changes in the disclosure of fees and some real pressure on financial companies to temper them. As evidence to this, he speaks about the financial services sector and the fact that it is the most profitable sector in the S & P:

Financial services is currently the most profitable sector in the S&P 500 – its share of corporate earnings rose from 5 percent in 1980 to an estimated 33 percent in 2007 – but that can’t continue. With low-cost pressures increasing, the profitability of this sector will inevitably diminish.

I think we as dividend investors need to consider this in a couple of different ways. First, many of the good dividend paying companies that consistently grow their dividend payments are part of this financial sector. I have been reaping the benefits of this profitability from companies such as Royal Bank of Canada, IGM Financial, Bank of America, and Citigroup. These companies have been some of the strongest performers in my portfolio from a share price appreciation perspective and consistently growing dividends. Without these profits, I do not think this would have happened.

Secondly, I beleive the industry has had a history of taking advantage of the investing public. Most investors are not as savvy as about mutual fund fees or stock trading fees – I know for a fact there are still people out there paying $100+ per trade – and financial services companies do not appear to be doing much about it. However, the pressure on them is mounting. There are more and more newspaper articles, and especially online resources (i.e. financial blogs) that are covering the high costs being charged. As Bogle suggests, the tide will turn and there will be more and more pressure to bring fees in line. This could have a profound effect on our dividend paying financial investments with potentially lower profitability leading to potentially lower share prices, and god forbid lower dividend increases (gasp!!). A diversified portfolio will be your best defense.

To wrap up, the most important point Bogle makes is how we will invest based on these fees – we will “buy and hold a diversified portfolio of corporations for the long term”. Nothing different than we should be doing today…

Advertisement: My favorite investing book about the power of dividend growth is the book The Single Best Investment: Creating Wealth with Dividend Growth.