Mutual Fund Fee Wars Will Encourage Bad Behavior

[RCL]

I don't normally read Bloomberg , but after reading this, I was wondering what others thought about this theory.

https://www.bloomberg.com/view/articles ... yptr=yahoo

A few snippets from the article:
"Investors are more likely to churn their portfolios as costs drop to nothing"

"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."

"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."

[TD2626]

Low fees are good, and churning is bad. The rational thing to do is to buy and hold in a low-fee, broadly diversified fund.

Maybe if Vanguard imposed a small fee - not a 200 to 500 basis point fee, but a 50 - 150 basis point fee - for buying and/or selling, it would discourage short term trading. I believe it does this on some funds already. It could reduce the ongoing expense ratios for long-term investors by the amount raised by the fees since it operates at cost. This could allow it to have lower expense ratios and compete more closely with Fidelity.

[HEDGEFUNDIE]

A 5% load off the top doesn’t just cost you 5%, it costs you the compounded effect of that amount over time, which really adds up. That would require quite a bit of churning to match that drag, so no, I don’t think load funds are the answer.

But I do think built in behavioral guardrails are not given enough respect on this forum. For example, I like currency hedged international stock funds, not because they have better return in the long term, but because they smooth out volatility which keeps you invested. Just witness the recent 900+ thread on whether to quit international if you don’t think this is a problem.

Talyor can’t be everywhere telling folks to “stay the course”. We need to find alternative solutions to the behavioral drivers of underperformance.

[columbia]

Low fees are good, and churning is bad. The rational thing to do is to buy and hold in a low-fee, broadly diversified fund.

Maybe if Vanguard imposed a small fee - not a 200 to 500 basis point fee, but a 50 - 150 basis point fee - for buying and/or selling, it would discourage short term trading. I believe it does this on some funds already. It could reduce the ongoing expense ratios for long-term investors by the amount raised by the fees since it operates at cost. This could allow it to have lower expense ratios and compete more closely with Fidelity.

I assume that said frequent traders would just go elsewhere with their business.

[tfb]

"Investors are more likely to churn their portfolios as costs drop to nothing"

It makes no sense. Supposed ERs are mandated to be 1% among all funds. Churning or not churning doesn't make any difference in your cost. If you are going to churn you just churn from one 1% fund to another 1% fund. Now ERs all drop to 0.05%. How does it make you more likely to churn? Load and commissions can discourage churning. ERs don't.

[nisiprius]

I don't care much for "it's bad, but paradoxically it's good for you." Like, whole life insurance is bad in itself but in reality it's good because the virtue of forced savings outweighs the vice of the savings going into a lousy and inappropriate investment.

It's perfectly true that my buy-and-hold habits were formed and reinforced back in the day of fixed commissions, when any brokerage transaction was likely to cost over $100--but that doesn't mean I think those commissions were good for me.

I don't think sales loads have ever reduced churn. Quite the contrary, they have motivated salespeople to encourage clients to churn. Don't forget, the premise of load funds is that they are so much better than no-load funds that they are going to earn back that load pronto, so you shouldn't really even think about them.

[grok87]

"Investors are more likely to churn their portfolios as costs drop to nothing"

It makes no sense. Supposed ERs are mandated to be 1% among all funds. Churning or not churning doesn't make any difference in your cost. If you are going to churn you just churn from one 1% fund to another 1% fund. Now ERs all drop to 0.05%. How does it make you more likely to churn? Load and commissions can discourage churning. ERs don't.

Agree

[Wakefield1]

What was Vanguard's name for a fee that was assessed on holdings/holders of certain funds for selling before a certain minimum holding time,with the fees being paid back into the fund (so as to benefit buy and hold investors at the expense of shorter term holders "traders" deferred contingent or something?
They might not have such fees anymore and they were not on all funds

[venkman]

"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."

That's kind of like saying it's actually good for cars to get lower gas mileage, because lower gas mileage encourages people to drive fewer miles; and if people drive fewer miles, they have less chance of getting into an accident.

[aristotelian]

If buying low cost index ETF's (and then tax loss harvesting at will) counts as bad behavior then I have been a very bad boy.

[Wm_o_o_o]

I am amused by why some people do'nt think the market will prevail.

Think about it, on the one hand we allow debate about whether Fund Fee Wars are good or bad but never question whether Trade Wars are good or bad because that is politics or some such silliness?

Grrrrrr.

Edit: before I get modded, my comment is no different to any of the others above, I am pointing out something ridiculous.

[Iorek]

"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."

That's kind of like saying it's actually good for cars to get lower gas mileage, because lower gas mileage encourages people to drive fewer miles; and if people drive fewer miles, they have less chance of getting into an accident.

Of course that is literally the argument being made now by DOT for rolling back CAFE standards in the "SAFE Vehicles Rule".

[cherijoh]

What was Vanguard's name for a fee that was assessed on holdings/holders of certain funds for selling before a certain minimum holding time,with the fees being paid back into the fund (so as to benefit buy and hold investors at the expense of shorter term holders "traders" deferred contingent or something?
They might not have such fees anymore and they were not on all funds

I think it was a short-term trading fee. I haven't seen those in a while at VG, although I'm totally in index funds now so it's probably unnecessary for those funds. I think it was common in sector funds which are more volatile.

My 401k plan limits us in terms of short-term trading of your existing contributions. If you have transferred money out of a fund, you cannot repurchase it for 60 days (I think) - except as new payroll contributions.

[AlohaJoe]

"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."

I was curious if the author was accurately reporting Vanguard's position or not, so I clicked the link and read Vanguard's paper. The paper actually just references another Vanguard paper, "Most Vanguard IRA Investors Shot Par By Staying the Course: 2008-2012". The title alone makes you think, "I think the author was maybe misrepresenting Vanguard's findings...."

For the most part, investors fared reasonably well by choosing lowcost investments and staying the course, even in the midst of a turbulent investment period. However, a subset of accounts did not fare as well: those who “changed course” and exchanged money between funds

The entire conclusion of Vanguard's study is that changing funds is bad and people should just pick target date funds. Yet the author says "the evidence on buy and hold is somewhat mixed", so he clearly wants the advisor to be making trades!

(It is also weird that he thinks the only way to prove a "winner" is to show him a Vanguard customer who is a billionaire. How many billionaires does the author have as customers to show that his way is better?)

[Greg in Idaho]

Yet another in the series: "I (and/or my industry) profits from X, therefore X is good (despite the appearances to the contrary)"

Funny that the blurb for the author even says: "He may have a stake in the areas he writes about."

[David Jay]

Low fees are good, and churning is bad. The rational thing to do is to buy and hold in a low-fee, broadly diversified fund.

Maybe if Vanguard imposed a small fee - not a 200 to 500 basis point fee, but a 50 - 150 basis point fee - for buying and/or selling, it would discourage short term trading. I believe it does this on some funds already. It could reduce the ongoing expense ratios for long-term investors by the amount raised by the fees since it operates at cost. This could allow it to have lower expense ratios and compete more closely with Fidelity.

They already have a 30 day restriction on Admiral class funds. They don't take your money, the "just say no".

[Fclevz]

Vanguard ETF's used to be commission-free only up to 25 buys and sells of the same ETF in a year. After that, you paid commission.
I don't see that on the website anymore, did they do away with it?

[goingup]

The good news is that brokerages are removing the high cost barriers to buying shares and investing. We now have easy on-line access to our accounts, low or no minimum purchases, low or zero purchase fees, and minuscule fund ERs. Really there's never been a better scenario for low-cost investing.

However, ETFs, mobile apps, and no trading fees can enable impulsive investors to act on a whim. That can't be good for long term wealth building. It's faster, easier and cheaper to blow up your portfolio. The only barrier to this is taxes (in a taxable account).

[greg24]

Never underestimate the ability of the advisor industry to attempt to portray low costs as a bad thing for investors.

[Nate79]

I do not think this has any effect on the behavior of investors. The behavior for those outside the BH community is very different than the buy and hold mentality around here. Reality is though that savings rate and overall asset allocation is by far the most important aspects for someone to have a chance at a successful retirement.

[rkhusky]

Vanguard does not let you easily buy back into a fund that you have recently sold for 30 days. (There is a work around that perhaps Vanguard should close) This is a good curb on churning. A few funds, such as Int Corp Bond, have purchase fees, which further discourages churning.

[Phineas J. Whoopee]

Auditionee: Therefore you should pay me lots and lots of money, potentially more than half your long-term return, to protect you from bad behavior I claim low expense ratios will encourage you to engage in.

Casting Director: Next!

PJW

[grok87]

Never underestimate the ability of the advisor industry to attempt to portray low costs as a bad thing for investors.

+1

[grok87]

Auditionee: Therefore you should pay me lots and lots of money, potentially more than half your long-term return, to protect you from bad behavior I claim low expense ratios will encourage you to engage in.

Casting Director: Next!

PJW

+1

[wolf359]

This is a ridiculous argument.

The fact that mutual fund expense ratios have dropped has nothing to do with sales charges. Fidelity was already selling funds that are no-load. They are competing with Vanguard and Schwab, who are selling no-load funds. The reduction in mutual fund expense ratios do not increase or decrease the sales commissions.

After introducing the argument that Fidelity is dropping expense ratios, he makes the argument that buying a mutual fund with a sales load will increase the likelihood that the customer will hold the fund and not sell. That may or may not be true, but it has nothing to do with the mutual fund fee wars.

He ends with this gem:

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.

I might listen to his argument if he can produce ANY retail customer of a high-fee high transaction cost actively traded mutual fund who is a billionaire (and got there by investing that way.) There are plenty of millionaire Vanguard customers.

Does Jared Dillian's arguments have anything to do with the fact that he is the former head of training at Lehman Brothers? Why "former"? September 15 (in a few days from now) is coincidentally the 10th anniversary of Lehman Brothers' bankruptcy.

I don't think his opinion worked out that great for his clients.

[Wm_o_o_o]

This is a ridiculous argument.

[snip]

He ends with this gem:

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.

I missed the wonder of "advisor alpha" when I skimmed the first time. That is priceless, thanks for pointing it out.

[Daryl]

What is missing from some of these arguments is any understanding of "tracking error". When I buy a passively managed investment, I want it to track the underlying index. A mutual fund/ETF that fails to adequately track the underlying is useless, even if it has a low fee!

Note: Tracking error can be a net benefit to the investor, and might even offset the ER.