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Investors Might Be Better Off In Higher Fee Investments???

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Sep 6, 2018 @ 4:23 pm

By Jared Dillian

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This is an interesting rationale as to why investors should pay more instead of less for investments.

Fidelity Investments introduced two mutual funds last month that cost investors nothing. One is focused on U.S. equities and the other on international assets. This is not a gimmick. The funds have already attracted almost $1 billion. The move was the latest salvo in a rapidly escalating fee war in the money-management industry. But let's not declare the death of funds with high sales loads and other fees just yet.

 

I am strongly in favor of lower fees, just like any rational person. This is simply capitalism doing what capitalism does. Consumers should benefit, especially with all those studies about how fees eat into returns over time. I am also in favor of money managers earning enough to make what they're doing worthwhile so as to preserve a wide array of consumer choice. People should be able to have more kinds of peanut butter than just Skippy and Jif.

Sort of lost in the whole discussion about expense ratios is that there are still a lot of mutual funds that charge significant sales loads, usually to pay for marketing and distribution. One might ask why someone would pay 4.5% off the top with no discernible difference in the quality of a fund. But fees on investment products can actually be good. Sometimes, such as with high commissions on stock trades, the sales loads ensure that investors are much less likely to churn their funds if they have to pay 200 to 500 basis points each time they want to get in or out. Fund companies will often drop the sales charge if investors switch between funds within the same complex, but most investors don't often switch. They will hold a fund forever — usually to their benefit.

(More: Fidelity's zero-fee funds unleash the power of free)

With the exception of Warren Buffett, the evidence on buy and hold investing is somewhat mixed. Based on my own experiences, investors who held a somewhat narrow portfolio of individual stocks for a period of decades have done the best. Out of any basket of 30 or so marquee large-cap companies, there is bound to be one Apple Inc. or Amazon.com Inc. These investors took a long view, partially because they were customers of a full-service brokerage and were too cheap to pay commissions on continuous stock trades.

When it comes to investing, humans are fallible and they happen to be more fallible when costs are low. Even Vanguard Group Inc. acknowledges that investors, left to their own devices in a fund complex with near-zero expenses, engage in sub-optimal behavior to the detriment of their portfolios, moving money in and out of funds like crazy. In a 2016 research piece on something called "Advisor Alpha," or the idea that a financial advisor can help you generate a better return than some benchmark, Vanguard said that based on a study of "actual client behavior, we found that investors who deviated from their initial retirement fund investment trailed the target-date fund benchmark by 150 basis points." 

 

(More:  Morningstar: Fund fees continue to fall)

So, Vanguard suggests that investors should work with an advisor from the firm's full-service brokerage, which few people probably even know exists. It seems a bit counterintuitive that the industry-recognized leader in low-cost, do-it-yourself funds actually sees opportunities in high-touch wealth management. But I'm a proponent of such "behavioral coaching" if it helps remedy some of that stupid churning behavior that plagues many retail investors.

It would seem that the ideal model would be for a wealth manager to diversify its clients across a range of low-fee mutual and exchange-traded funds, but high-touch isn't free. How much could someone reasonably charge for the simple task of picking a diversified portfolio of index funds, especially when a roboadvisor will do it for mere basis points?

I have always been of the opinion that investors have done best in high-fee products with high transactions costs, bought and held over time, which are a built-in form of "advisor alpha." I will change my mind when I meet my first Vanguard customer who is a billionaire.

Jared Dillian is the editor and publisher of The Daily Dirtnap, investment strategist at Mauldin Economics, and the author of "Street Freak" and "All the Evil of This World." He may have a stake in the areas he writes about.

 
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ALL CRAP! The active-passive debate has been around for 25 years and these high-cost and delusional active manager types never give up. Two sentences at the end show what this idiot is really about. He wants more and more, and only a $billion would satisfy him "I will change my mind when I meet my first Vanguard customer who is a billionaire." And in the footnote, regarding this so-called "author", "He may have a stake in the areas he writes about."  OF COURSE, HE DOES! 

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