The report put out by the Task Force on Financial Literacy came in for plenty of criticism because it was stacked with insiders at financial institutions that profit from selling financial products. The Globe and Mail’s Rob Carrick pointed out that Canadians can be made a lot savvier about money with better disclosure of fees, rates, terms and conditions. In a sidebar accompanying the main article, Mr. Carrick says that investors would be better served if investment firms showed us how much we are paying for mutual funds — not just in percentage terms but dollar amounts.
You would expect that if investors were made aware of how much fees they were paying, they would wise up and choose low cost investments. Unfortunately, that doesn’t seem to be case. Consider an experiment described in a paper titled Why Does the Law of One Price Fail? An Experiment on Index Mutual Funds. Researchers asked 391 people selected from Harvard staff members to allocate a hypothetical $10,000 among four real S&P 500 index funds. The funds had different front-end loads and different annual expenses. All subjects received the funds’ prospectus and were provided with a large incentive: they will be paid the profits on their investment at the end of an one-month period but will not be responsible for any losses. Some subjects received additional information in the form of a one page summary of fee information. The optimal portfolio would allocate everything to the lowest-cost fund but the researchers added a twist. All the funds available for selection had different inception dates and hence reported different average annual returns in the prospectus.
The results were dismal. Less than 1 in 5 subjects who were supplied with only a prospectus picked the lowest-fee fund. The group with a one-page cheat sheet that summarized the fund fees improved their portfolio allocation but only modestly. The researchers found that subjects “placed heavy weight on irrelevant attributes such as funds’ annualized returns since inception”. They conclude that “although better disclosure and financial education may be helpful”, their research indicates that “their effect on portfolios is likely to be modest”.
