Congratulations! You have suddenly amassed a sizeable nest egg through an inheritance, selling your business or by winning the lottery. Every corporate bank is enticing you to let their private bankers do their magic with your money! But should you join their elite clubs?
What is private banking?
Private banking is the term for financial services that banks provide to high-net-worth individuals. Examples of such services are:
- Investing and portfolio management (incl. access to private investments)
- Privacy of you and your family
- Trust services
- Tax and legal requirements
- Succession planning
Besides these services, some private bankers even provide services that help you buy art or a sports franchise. Yes, if you are lucky enough to have a lot of cash at hand, they will help you buy your own NBA team!
Just like Steve Ballmer, former CEO of Microsoft, who paid $2 billion to become the owner of the Los Angeles Clippers. His explanation for the purchase:
“This was the opportunity that really fired me up and got me going and I am delighted with it.”
You better be fired up about something to spend $2 billion dollars on it!
What are the minimum requirements?
To be eligible for private banking many banks apply a minimum threshold. I looked around and have listed a few banks with their investable assets requirement before you can enjoy the benefits of private banking.
These minimum requirements may seem achievable right? But consider this as the absolute minimum. These banks offer private banking services to main street. The services that these banks offer on these levels are not as exclusive as you may expect.
If you really want to indulge yourself with attention from the crème de la crème of smooth talking private bankers, join banks such as Goldman Sachs, JP Morgan or Abbot Downing. Don’t forget to bring a lot of money with you as the minimum is $10-50 (!) million in investable assets.
What are the benefits of private banking?
There are many benefits to private banking. The higher your net worth the bigger the benefits. Let’s list some benefits in random order:
- Your own private banker on speed-dial (who doesn’t want to brag about that?!)
- Through your private banker you have access to specialists for tax, legal, etc. related matters
- Access to special types of investments only available to private banking clients
- Special rates on mortgages, credit-cards, etc.
- And most important of all, peace of mind knowing that your wealth is taken care of
In case you have amassed a significant amount of wealth over multiple generations, succession planning and passing over your wealth to the next generation can be very complicated. A team of private bankers and specialists can ensure a smooth transition from one generation to the next.
On a personal level, I can imagine that being (extremely) rich can be very lonely. You cannot always be sure that people you meet have your best interests at heart. People often need something from you. That’s why it’s pleasant to talk to a private banker and be open about your finances without the feeling that he is trying to take advantage of you and rip you off.
Privileges of private banking come at a price
Almost nothing in life is free. Definitely not private banking. The largest part of private banking fees are because of labor. Having a private banker on speed-dial, while he and his team are managing your wealth in a tax-efficient manner, is expensive.
These expenses are exactly the reason I think private banking is a foolish choice for most people. If you can barely reach the minimum investable assets requirement of let’s say $250,000, don’t even think about upgrading to the premier league.
Private banking often costs about 2-3% of investable assets. So with $250,000 in investable assets you will pay $5,000-$7,500 every year in banking fees. If your investable assets increase with 10%, so do your expenses. I cannot emphasize enough how detrimental expenses are to protect and increase your wealth.
A comparison between two portfolios
Let me illustrate the impact of expenses by comparing 2 portfolios.
Both portfolios start out with $1 million dollars in invested assets. Both portfolios are well-diversified through hand-picked actively managed funds in case of the private banking portfolio, and index-funds in case of the do-it-yourself portfolio.
As mentioned in another blog, 90% of active investment managers cannot beat the market or even under-perform the market. Here, I give the private banker the benefit of the doubt and assume he generates an investment return in line with the market (6%).
Because the private banker can use many specialists and services in view of taxes, legal structures, specific knowledge, etc. He can add value to the client by generating an additional return of 1.5%. I think 1.5% is definitely on the higher end, but let’s assume the private banker is fantastic at his job.
The personalized services the private banker offers to the client are not free. The private banker charges the client for 3% of the invested assets every year. After 25 years the private banker tripled the client’s money. An achievement any private banker could be proud of!
The do-it-yourself investor however, generates the same investment return but cannot improve his return because he lacks knowledge about taxes and strategy. Because the do-it-yourself investor invests in straightforward index funds, the expense ratio is only 0.25%.
By following the same strategy and turning down many offers from private bankers willing to do the thinking for him, his portfolio has more than quadrupled. A difference of more than $1 million! Now that’s an achievement the ‘know-nothing’ investor can be proud of!
I would definitely choose to be a do-it-yourself investor quadrupling my money than spending $1 million on a nice guy in a fancy suit.
- Using private bankers can be a intelligent decision for the ultra-wealthy. The high expenses can often be reclaimed because of savings in taxes, succession planning, etc.
- For most people barely meeting the minimum requirement in investable assets, private banking is a very expensive ego-booster
- Expenses matter tremendously over a long period. High returns are uncertain but expenses are guaranteed.
- There is no one-size-fits-all model in investing and reaching financial freedom. Always do your own research!
What are your thoughts about private banking? Were you ever contacted by your bank offering you the opportunity to join private banking?