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Of the factors that go into sound investment decisions, fees are one of the easiest to control.
If you select mutual funds and other investments that don’t charge high costs, your overall performance will improve, all else being equal. Compared to market gyrations, fees are highly predictable, and they typically don’t change much from year to year.
Yet new research suggests that people often fail to select low-cost options, even when those choices are fairly obvious. It could be another example of people behaving in ways that aren’t fully rational.
“When left to their own devices, a substantial number of people do not make optimal choices with respect to cost,” wrote Stephen Wendell, head of behavior science at Morningstar, in a recent article.
“Individual investors partially ignore the fees they are paying, with potentially serious consequences.”
That’s not to say fee trends aren’t going in a favorable direction for investors — they are.
For example, participants in workplace 401(k) retirement plans paid just 0.45 percent on average in stock mutual funds last year, the equivalent of $4.50 in fees for every $1,000 invested, according to the latest fee-tracking study by the Investment Company Institute.
That’s down from 0.48 percent in 2016 and 0.77 percent in 2000. Bond funds and hybrid stock-bond portfolios also have become less costly.
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“This downward trajectory greatly benefits retirement savers,” said Sarah Holden, the institute’s senior director of retirement and investor research. Mutual funds account for roughly two-thirds of the assets in 401(k)-style plans.
Also, front-end loads or commissions have dropped over the years, both on funds offered in 401(k) plans and otherwise. No-load rivals have proliferated, and commissions have declined even on those portfolios that still levy them. Front-end loads of 8.5 percent on mutual funds, common decades ago, have all but vanished.
But are these favorable developments the result of increasingly savvy investors demanding more cost-efficient choices, or are other factors at play?
Two recent studies cited by Wendell in his paper suggest that some people still are fairly clueless when it comes to fees and other expenses.
One British study, from that country’s Financial Conduct Authority, examined how respondents selected funds that were similar except for their costs. Even with a clear presentation of fees, investors made high-cost choices 27 percent of the time.
Only when researchers provided additional reminders, urging investors to review fees for the various funds and offering easier-to-understand cost comparisons, did preference for high-cost choices dwindle.
The other study, by Morningstar and the University of Chicago, addressed the fee-choice question in a different way. In this effort, researchers gave people a hypothetical $10,000 to invest among three identical index funds that differed only in their expenses.
The results are in, and survey upon survey proves that Americans suffer from a painful lack of financial literacy. Whether it’s in knowledge about retirement planning or responsible investment due diligence, consumers continually fail to make the gr The Street
The best choice would be for each person to invest the full $10,000 in the lowest-cost option, yet only 42 percent of the money went in this direction, with most people instead splitting their money among different choices.
Only when the researchers required people to choose only one fund, rather than spreading it around, did more of them pick the lowest-cost, and thus smartest, option.
Improving fee awareness
Results from these and other studies provide some interesting implications:
- The lengthy decline in fees over the past couple of decades likely reflects competition, the advent of low-cost index funds and other factors, rather than the demands and desires by an increasingly sophisticated public, Wendell observed. If anything, there’s evidence from other studies that Americans’ financial literacy hasn’t improved all that much, if at all.
- Changing how fees and performance are presented doesn’t always help much in nudging investors toward low-cost options. However, limiting the number of investment selections does seem to help. On average, 401(k) plans let workers choose from among 20 funds/other options, according to the latest survey by the Plan Sponsor Council of America. That might be too many choices.
- When people are uncertain, they may hedge their bets by spreading money around. This behavior, called “naive diversification,” can be triggered by choice overload. “It’s only natural for individuals to resort to a shortcut like naive diversification and allocate their money somewhat evenly across all available options, even ones that are overpriced,” Wendell wrote. But it’s often not the best decision.
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Mutual funds are required to disclose annual expenses in a standardized manner — a factor that is supposed to help guide investors to making better decisions. Fee information is presented in fund prospectuses or disclosure reports. It also can be found fairly easily on fund-company websites and those run by research services such as Morningstar.com.
Many other types of investment fees — for account-management services, IRA annual charges and so on — typically also can be found without much trouble.
In short, there are more low-cost funds than ever before, but many people still aren’t taking full advantage of them. The studies cited by Morningstar suggest that a lot of investors still aren’t getting the message or, more likely, they’re distracted by all the other messages out there.
Cutting fees on credit cards
Speaking of fees, a recent survey suggests it’s easy to get credit-card fees waived if you simply ask — though you might encounter problems if you make a habit of it.
Some 84 percent of credit cardholders who asked for a late-fee waiver were successful the most recent time they requested one, according to the survey by CreditCards.com. Also, 70 percent of respondents said they were able to get annual fees lowered or eliminated, and 56 percent who requested a reduced interest rate got it.
“The credit card business is competitive, and your odds (of obtaining a fee waiver or rate reduction) are highest if you have good credit, a history of timely payments and if the card issuer fears losing your business to a competitor,” said Greg McBride chief financial analyst at Bankrate.com, a company affiliated with CreditCards.com.
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According to the survey, 60 percent of cardholders said they have made at least one of these requests, and 89 percent said they have received a favorable request at least once. Yet the survey indicated most consumers don’t ask — apparently because they didn’t know it can be done.
McBride said it’s not wise to ask for relief too often.
“This works best when an otherwise timely payer has a one-time slip-up,” he said. “Don’t call up every three months asking the issuer to continue reducing your rate, especially in a rising-rate environment.”
He also suggests making requests from a position of strength. People with good credit and those with multiple accounts at the same bank will have more negotiating power, while recent late payments can hurt.
“Shop around and know what other issuers are offering,” he said. “Mention that you’re willing to take your business elsewhere, but also be prepared (to do that) if the issuer calls your bluff.”
Reach the reporter at firstname.lastname@example.org or 602-444-8616.
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