With their combination of low fees, tax efficiency and simple, autopilot investing style, index funds seem to have captivated American investors. Indeed, the Vanguard 500 Index Fund is the third largest of the more than 8,000 funds, with assets exceeding $111 billion. And investors have plowed money into the newest indexers, called exchange traded funds. ETF assets hit $296 billion in 2005, up from just over $1 billion 10 years earlier.
Clearly, investors have embraced the core belief that minimizing annual fees boosts long-term gains.
Or have they? Three researchers at Wharton, Yale and Harvard wanted to find out. Why, they wondered, do investors persist in holding trillions of dollars in high-fee funds despite the well-publicized evidence that low-fee alternatives offer higher returns over the long run? "It struck us that most people just don't know what mutual fund fees are. So we set out to actually test that," says Brigitte C. Madrian, professor of business and public policy at Wharton. The result is a paper entitled, "Why Does the Law of One Price Fail? An Experiment on Index Mutual Funds," by Madrian, James J. Choi, professor of finance at Yale, and David Laibson, economics professor at Harvard.
Their conclusion: Investors appear to have a poor grasp of the fee issue, failing to minimize fees even when the benefits are presented in a clear and incontrovertible disclosure. "Most investors don't understand the importance of mutual funds' fees," Madrian notes.
To zero in on the issue, the researchers asked test subjects to choose among a variety of index-style funds with identical stock holdings but different fees.
Index funds buy and hold the stocks or bonds contained in an underlying market gauge, such as the Standard & Poor's 500 index, composed of the 500 largest stocks traded on American exchanges.
[continue]
Page 1 of 6
> >>