Consumers Fail to Avoid Investing Fees

Fees on retirement account mutual funds can sap thousands of dollars away from nest eggs. They're often buried away in paperwork, but new research suggests that even if consumers know about the fees, they're not good at avoiding them.

On Capitol Hill yesterday, researchers from RAND shared those disturbing findings, which are based on a survey of over 1,000 respondents. The participants were asked to invest money in funds carrying different fees. One fund was clearly the best; it offered the lowest annual fees as well as lowest sales commission charge (also known as "load"). All of the funds were S&P 500 index funds, so would produce equivalent returns.

But only half of the people selected that low-fee fund. In fact, one-third put their money in the most expensive fund. They were, in other words, effectively throwing money away.

The researchers, Angela Hung and Joanne Yoong, couldn't say exactly what caused such poor decision-making, but they suspect it has to do with financial literacy. The people who had greater financial literacy skills (they understood compound interest, for example), were more likely to do better at choosing the lowest fee fund.

Among their other findings:

• Older consumers, women, and minorities tended to be less financially sophisticated. (I don't generalizations like that, but those were the findings.)

• People tend to rely on faulty "rules of thumb" when making investment decisions that lead them astray. For example, they tend to hold a limited range of equities, such as focusing on company stock, which can doom their savings if the company collapses. They also tend to make their investment decisions once and then stick with them, rather than adjust them.

• A graph, designed to be helpful and provide users with additional information, actually had a negative impact on consumers with low financial literacy scores, perhaps because they felt overloaded with information.

The study brings up the question: Do people need to become more financially literate, or does the financial world need to change so it's not so complicated? Take annuities, for example. A great tool for some people, sure. But even as someone who's written about them before, I would have trouble providing an accurate definition at a cocktail party.

I have basic faith in people's ability to make decisions based on common sense. Most people know that saving money is important, even if they are unable to do so. What if our financial world could be navigated by common sense? What if we didn't need to know fancy concepts, such as annuities and no-load funds? Is such a world possible?

It might be a more realistic goal than expecting everyone to gain such a degree of "financial literacy" that they can deftly navigate the current system.

Read more about financial literacy: "The Financial Literacy Crisis."