The modern capitalist economy relies upon financial institutions to facilitate translations between different parties. For example, if you want to buy stock in a certain company, you must use the services of a stock broker to purchase shares of the stock on your behalf. Financial institutions like banks and stock brokerages that act as middlemen for financial translations are sometimes called financial intermediaries. While financial intermediaries allow lenders and borrowers to connect, they introduce several potential disadvantages.
Lower Returns on Investment
Financial intermediaries are in business to make profit, so using their services can result in lower returns on investment or savings than what might be possible otherwise. For example, when you save money at a bank, the bank pays you interest on the money you save and then lends those funds to other consumers or companies at a higher interest rate to make a profit. In this case, the bank acts as an intermediary between you and the borrower. While you will receive interest on your savings from the bank, you could potentially make more money if you lent directly to a borrower rather than channeling money to them through a bank.
Fees and Commissions
Another possible drawback of financial intermediaries is that they may impose fees or charge commissions for their services. For instance, a stock brokerage firm might charge you a flat $20 to place buy and sell orders for stocks, which would reduce the amount of money you can actually invest. Similarly, a mutual fund might impose commissions that amount to a certain percentage of your total investment, which would serve to reduce the effective annual return on your investment.
Financial intermediaries like stock brokers and personal financial advisers might provide helpful advice about investments and savings opportunities, but their overall goals may be counter to the goals of their clients. For instance, as an investor, your goal might be to make as much money as possible to grow your net worth. A financial adviser or stock broker, however, ultimately wants to profit by charging you fees and commissions that serve to sap your net worth. Differences in goals could potentially result in intermediaries giving sub-optimal advice or taking advantage of clients.
It is important to consider the cost of fees, commissions, interest rates and potential alternatives before making any sort of financial transaction. Consumers should be wary of opportunities that seem too good to be true or that promise high guaranteed returns.