NEW YORK – The most tenacious bargain hunters often take pride in finding the best price in town and might even sniff at less-determined shoppers who simply snap up what is put before them. But it seems some savvy investors lose their keen eye for a deal when it comes to index mutual funds.
According to a new study, in some cases where investors use a broker to help pick index funds, they can incur costs that are many times higher than those of the least expensive index funds. The disparity can be particularly galling for the many investors drawn to index funds in large part for their low expense levels.
Index funds are like off-the-shelf products with no assembly required because the stocks they contain simply mirror those that make up an index such as the Standard &Poor’s 500. Because the stocks in these funds don’t have to be chosen by someone with a Wall Street address, expenses are often held to a minimum.
As there is no difference in the performance of two funds that are based on the same index, a comparison comes down to costs. The study, which examined 141 index funds that are based on the S&P 500, found that an average investor with a $10,000 investment held for 20 years would pay fees of $7,600 for a so-called load fund, while those owning a no-load fund would pay closer to $2,600, a savings of $5,000. Loads refer to fees imposed when investors sell shares.
Making matters worse, those who invest in the load fund could also have to pay broker fees, whereas as a true no-load fund carries no such fees.
“The structure of broker compensation is designed to provide a vehicle for funds to sell their shares,” said Mercer Bullard, founder of Fund Democracy, a mutual fund shareholders’ advocacy organization that helped conduct the study.
The study, partly financed by a group of fee-only investment advisory companies that operate under the banner Zero Alpha Group, suggests brokers are not always acting in the best interest of investors. “We’re finding funds are paying brokers in order to attract investors to their more expensive and profitable funds,” said Bullard. The fees, while not illegal under the cadre of laws that govern mutual funds, mean index fund investors should be diligent in asking whether they are getting the best deal.
Bullard, a law professor at the University of Mississippi and a former assistant chief counsel at the Securities and Exchange Commission, is quick to note he is not begrudging brokers who provide valuable investment advice and services but is concerned that some investors are paying more than is necessary.
Jeff Tjornehoj, an analyst at Lipper Inc., which tracks funds, notes that some investors seeking advice might benefit from using a broker even if it means paying more. “Those who use a broker are getting an expert opinion on how to allocate their portfolio.”
In other cases, investors who use a broker for other investments and pay routine fees might not want to bother going outside the usual channels. However, Tjornehoj said investors who know what they want should consider making this investment on their own.
“If you’re not getting valuable financial planning advice then they truly are expensive,” he said of some index funds bought through a broker. He said for those investors who are clear on what they want “there is no reason to go through a broker.”
Tjornehoj says investors should be wary once expenses for an index fund climb above 60 basis points, or 0.06 percent, and should ask questions about how brokers are being paid.
“People seem more afraid of asking their broker important questions than they are of the dealership where they’re buying their next car,” Tjornehoj said. “You can still kick the tires of your portfolio and say I don’t find this arrangement particularly efficient.”
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