The Two Greatest* Financial Innovations

The two greatest financial innovations of the 20^th century are:

• The 30-year fixed rate residential mortgage

• The index fund

I put an asterisk next to “greatest” for a reason—there have been some unintended consequences.

First, Mortgages

Pretty neat—you don’t have to save up cash to buy a house. You can pay for it over time and build equity, and once you pay off the loan, you will have 100% ownership of a house that has probably appreciated in value. The bad news? You are going to pay a lot of money in interest. Hundreds of thousands of dollars in interest. You will end up paying for the home twice, and then some, depending on the level of interest rates.

Back when I was doing my personal finance thing about five years ago, I used to talk about this all the time. Yes, you should care about the rate of interest, but you should also care about the dollars spent in interest. If you pay off your mortgage quickly, or at least prepay the hell out of it, you will greatly reduce the dollars you spend in interest. And it doesn’t take much. Even $250 extra a month will drastically reduce the amount of interest you have to pay over the life of the loan.

Some quick examples: In 2015, I took out a mortgage for $750,000. I paid it off in 3.5 years. The total interest I paid on the mortgage? $70,000. In 2024, I took out a mortgage for $3.5 million. I owe a little less than $700,000 on it today. The total interest I have paid so far? About $210,000. If I did not prepay this mortgage and just made the minimum payments over the life of the loan, I would have paid millions in interest. I can probably find some cool things to do with several million dollars, rather than paying interest to the bank! I like banks, but I don’t want to make them any more profitable than they already are, at my expense.

Most people don’t do the math on this… or do any deep thinking about it. They keep making that minimum payment, as debt indentured servants, for 30 years. That sucks up a lot of cash flow you could be using for other things. I am saying something somewhat controversial here, but everyone should be able to pay off their mortgage in 10 years. If you can’t, then you bought too big of a house.

As for the Index Fund

We all know the consequences. Vanguard is like one big slow-detonating bomb. I submitted an article to Reason recently, and my editor said something about something conservative like “safe” index funds. What? Index funds are not safe. Index funds are the stock market? The stock market is safe? You’re going to put all your life savings in this thing that moves around, on average, 1% a day? And in times of crisis will move around 10% a day? That seems like insanity to me. 

Maybe since I have worked in the stock market, and I know how the sausage is made, I really want no part of it. 80% of USDA chicken inspectors no longer eat chicken. Stocks are risky, and through financial innovation, we have convinced generations of people that they are actually safe. Incredible. Financial advisors tell me that people walk in their office and ask where they can get some of those “safe” index funds. There is a lot of education that needs to happen.

But yes, they are low-cost. You don’t need to pay a portfolio manager seven figures to pick stocks; you just get some flunky to pick all the stocks, sit on them, and do all the adds and deletes and rebalances. So, the costs come down dramatically. And yes, the index fund promoters rightly point out that fees eat into your returns over time. I don’t want to get into a discussion about fees here, but I’ll just make the point that fees should not be your primary concern.

Anyway, in 1997, 2% of assets under management were passive, and now they are 56%, last I heard. It is even higher in Japan. I am not happy about this development. Basically, if you are investing in an index fund, you don’t so much care about individual stocks; you care about corporate earnings in the aggregate, which are a function of economic growth. You are betting on economic growth, which has been a pretty good bet over the years. But it might not be in the future! I can think of a million reasons why. I prefer to invest in a variety of things that aren’t much correlated to each other, which produces a low-volatility portfolio that also goes up over time, just a little less.

A Better Innovation Than the Index Fund

Which brings us to The Awesome Portfolio. The book is coming out in less than a month. Look, I’ve been in the investment research business for a long time, and one of the weirdest things about it is that people will fork out $1,000 for a newsletter but get tight when it comes to buying a $30 book. And yes, a book is a time investment, and who has four hours? This is four hours that will change your life and probably save you untold amounts of money. 

A $32 investment that could save you hundreds of thousands or more. Honestly, it is an even better financial innovation than the index fund. Preorder the book here, and have it in your hands on September 8. I thank you in advance.

Jared Dillian, MFA