Do-it-yourself
investors win the race | | |
| 2. Buy
funds with lower costs (excluding loads and 12b-1 fees)?
As for putting their clients in low-cost funds, the answer is: They
do not. Brokers aren't particularly fee-conscious. Not only do investors
pay loads, whether a front or back-end load or a 12b-1 distribution
fee, they pay higher "nondistribution" charges (operating
and other expenses).
3. Hold funds with superior
performance?
As for whether brokers sell funds with superior performance, the
answer is no, unfortunately not. The academics looked at returns
net of nondistribution expenses, which means they looked at returns
before deducting broker fees. In their words: "Brokers channel
investors toward equity and bond funds that deliver performance
that is substantially inferior to the performance of funds sold
through the direct channel." How inferior? Broker-sold equity
funds lag their direct-sold competition by 77 basis points, bond
funds underperform by 138 basis points and money markets by 21 basis
points. A basis point is one-hundredth of a percentage point. Apply
that information to assets under brokers' management, and we're
talking about a cost to clients of $5.5 billion annually for equity
funds, $3.3 billion for bond funds and $120 million for money market
funds. And that doesn't even count load costs!
4.
Get excellent advice about asset allocation?
Asset allocation superiority?
Um, no. We've already noted that clients have a larger portion of their assets
in cash equivalents. How smart is that? "Clients of brokers are underinvested
in long-term investments, relative to direct-sale investors," say the study's
authors. Result: Independent investors outperformed. 5.
Avoid falling into behavioral traps such as chasing past performance?
The evidence on which type of investor, independent or advice-guided, is more
prone to fall into performance-chasing traps is inconclusive, though the authors
say that they can "marshal evidence that both channels display return-chasing
behaviors." The authors go out of their way to give brokers
and financial advisers the benefit of the doubt, stating that since they offer
no tangible benefits, they may instead offer intangible benefits. For instance,
they may "help investors save more, better customize their portfolios to
risk tolerances and/or increase overall investor comfort with their investment
decisions." Hmph. I would venture to guess that most
investors seek help from brokers for tangible benefits, such as the assurance
of meeting retirement goals. As for intangible benefits, how comfortable can they
be with investment decisions that are inferior to those of do-it-yourselfers?
But the authors do concede the possibility that "brokers
may give priority to their self-interest. ... This alternative view
predicts that brokers' advice would maximize the value of present
and future fees and other benefits to the brokers."
No kidding! Ya think? Another
study
Here's more proof of broker self-interest: A study
released last week shows that investors who buy index funds through
brokers pay substantially more for the privilege than do independent
investors who go through no-load channels. Not only are brokers'
clients paying distribution loads, which would be expected, but
also higher operating expenses, to the tune of nearly half of a
percentage point.
A half of a percentage point -- or 48.9 basis points
to be exact -- is a big deal.
"On a $10,000 investment earning an annual return
of 10 percent over 20 years, the average investor in no-load, no
12b-1 fee index funds would pay approximately $2,582 in operating
expenses," according to the study's authors, who assume an
average expense ratio of 21.5 basis points. "The average investor
holding load index funds would pay $7,600 in operating expenses.
"Although one would expect using a professional
adviser to improve an investor's performance, instead the investor
pays a significant penalty," conclude the study's authors.
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