Print

Email story

Comment

Email editor

Buying index funds through broker is costly, study shows

By TIMES WIRES
Published December 24, 2006

Using a broker to buy index-based mutual funds could prove hazardous to your wealth.

That was the conclusion of a recent study of S&P 500 index funds - those that mimic the Standard & Poor's 500-stock index.

These "plain vanilla" funds are essentially commodities, holding nearly identical investment portfolios. The variation in performance among such funds depends almost entirely on the annual fee each fund charges. Those fees can vary dramatically, from a low of 0.07 percent to a high of 1.45 percent. The lower the fee, the higher the return to investors.

Therefore, investors who pay a fee to a broker to help them choose index funds should expect the broker to steer them to the lowest-cost and thus highest-returning fund, said Mercer Bullard, co-author of the study and founder and president of Fund Democracy, a shareholder advocacy group that was a sponsor of the study. Yet the opposite happens, he said.

Investors who bought funds that don't charge fees to pay the salespeople who market them paid an average of $2.15 in fund operating expenses annually for each $1,000 held in the funds.

Those who bought through a broker ended up in index funds with average annual operating expenses of $7.04 per $1,000 - more than three times as much - and paid the broker an additional $1.56 a year per $1,000 invested.

"Although one would expect using a professional adviser to improve an investor's performance, instead the investor pays a significant penalty," said Edward O'Neal, assistant professor at Babcock Graduate School of Management at Wake Forest University in Winston-Salem, N.C. "When investors used brokers they paid twice: First, they paid the broker; second, they paid a penalty in the form of higher fund fees."

The differences may seem small, but the resulting disparities in portfolio size mount over time. With nearly half of U.S. households owning mutual funds, and with U.S. mutual funds holding $10-trillion in assets, seemingly small differences are too costly to ignore, said O'Neal, the study's other author.

How costly are they? The broker-bought index fund would cost $29,560 more at the end of 20 years for someone socking away $500 a month, assuming a 10 percent annual return before fees. After 30 years, the investor in the low-cost fund would have $1,080,845, versus $942,511 if he invested in the higher-cost index fund. That's a $138,334 difference.

The study's authors weren't criticizing the brokers' fees - just the fact that the brokers steered investors into higher-cost products.

"It raises some troubling questions about whether brokers are acting in the best interest of their clients," said J. Christopher Kerckhoff Jr., vice president of Plancorp., a Chesterfield, Mo., advisory firm. Kerckhoff is a member of Zero Alpha Group, a coalition of independent planners, which co-sponsored the study.

[Last modified December 23, 2006, 20:35:55]