Mutual fund shopping pays off

Steve Tripoli Feb 8, 2007

Mutual fund shopping pays off

Steve Tripoli Feb 8, 2007


MARK AUSTIN THOMAS: Most of us shop hard for big-ticket items like a car, but then we don’t bargain-hunt for something that involves a lot more money. An investment portfolio can cost hundreds of thousands of dollars over a lifetime. Yet when it’s time to buy products like mutual funds, we don’t shop around. Steve Tripoli has some new findings about our money behavior that could save big bucks.

STEVE TRIPOLI: Why do so many people buy mutual funds that charge high fees?

Three researchers in behavioral economics couldn’t figure it out. So they took a bunch of financially-savvy graduate students from the University of Pennsylvania’s elite Wharton business school.

The students were given a hypothetical $10,000. They also got prospectuses describing four index mutual funds that track the S&P 500.

They were told to invest that $10,000 however they liked among those four funds. And guess what.

BRIGITTE MADRIAN: Only a very small fraction of students picked the lowest-fee portfolio, which would of course be the sensible thing to do in this case.

Sensible because one S&P 500 index fund has pretty much the same investment return as any other.

That’s why the researchers, including Brigitte Madrian of Harvard who you just heard, used index funds in the study, but investment returns aren’t the only way to measure a fund’s gains over time.

Fees for these funds ranged from $309 in the first year to $589. That info was included in the students’ prospectuses. Yet almost all of them failed to stick all their money in the lowest-cost fund.

Again, Brigitte Madrian:

MADRIAN: One conclusion is that investors don’t know what information is most salient in making an asset-allocation decision.

Hmm, the researchers thought. Maybe the prospectuses were too long, or too confusing. So they tried again, but this time each student got a one-page cheat sheet where all the fees were in large, bold numbers.

Over 80 percent still didn’t go for the lowest-cost fund. Harvard’s David Laibson is another of the researchers.

DAVID LAIBSON: If Wharton MBA students don’t understand this on something as simple as an index fund, we’ve got to worry more broadly about the general public’s understanding of the financial products that they’re buying, particularly when those products get more complex than an index fund.

If you’re paying even an extra 1 percent a year in mutual fund fees, that can knock your final retirement kitty down by 30, 40, even 50 percent.

Laibson says one problem is that most mutual fund ads don’t talk about fees.

I’m Steve Tripoli for Marketplace.

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