Saturday, October 23, 2021

Individual Investors Still Don’t Understand Fees

Don’t blame investors — advisors and the industry need to communicate better, says fiduciary group.

True or false? “The management cost of investments like mutual funds and ETFs are included in the fee I pay my advisor or investment platform.”

For boomers, the wisdom of a few extra years was evident: In that survey question, only 36% of boomers found this false statement true, while 71% of millennials considered it true and 51% of Gen X investors agreed with it.

But while older investors exhibited more savvy in this case, the need for greater clarity about investment fees bridges all ages, according to participants in a recent program conducted by the Institute for the Fiduciary Standard. Founded in 2011, the Institute is a research and education institution whose purpose is to promote the importance of the fiduciary standard in investment and financial advice, as stated on its website.

The Stark Reality

Brie P. Williams, vice president head of practice management at State Street Global Advisors for its Global SPDR business, put this and other surveys in context at the Institute’s Sept. 20 webinar “Investor Understanding of Fees.” She noted that the industry as a whole has been “talking a lot about transparency and how far we have moved the needle” in educating investors.

“Yet the stark reality that is still prevalent today is how the individual investor is grasping — or really not grasping — what they are paying” for in terms of guidance or fees. “That finding may raise eyebrows in financial circles, but it does not surprise my team,” she said.

Williams was joined in the webinar by Aron Szapiro, head of Retirement Studies and Public Policy for Morningstar, and Knut A. Rostad, founder and president of the Institute for the Fiduciary Standard.

Rostad is an advocate for changing the perception of so-called “investor confusion” to one of “information confusion and omission.” The program was part of “Fiduciary September,” created by the Institute for the Fiduciary Standard “to remind investors and the planning profession why fiduciary advice matters,” according to the Institute’s “Knut’s Views” posted on its website. Darren Fogarty, research analyst with the Institute, coordinated and hosted the program.

Williams put this “information confusion” in perspective with additional survey findings in other areas of investment. For example, while a majority of investors are at least aware of both expense ratios and basis points, less than one third of investors understand each “completely.” And more understand expense ratios than basis points.

Misperception About “Low-Cost”

When it comes to low-cost products, the survey found there is a limited understanding of just how “low” low-cost actually is when it comes to fund expenses.

“Among investors who think they understand expense ratios and/or basis points, the average expense ratio they consider to be no longer ‘low-cost’ is 0.61%. That’s higher than the asset-weighted average expense ratio of U.S. open-end mutual funds, which is 0.51% and the average asset-weighted ETF cost at just 0.20%,” according to information Williams presented from the survey.

It’s clear that the industry needs to “do more work on investor education — what they own and why they own it,” Williams said.

Aron Szapiro of Morningstar acknowledged the shortcomings with investor information, but said research shows investors are “increasingly cognizant that fees erode their returns and they are looking for low-cost investment strategies… It’s unquestionably a better time to be an investor today than 10 years ago…. But there are still a lot of challenges.”

Fund fees have been coming down for decades, he noted. Investors are “pouring money” into the cheapest funds — and even the “cheapest of the cheap,” he added.

An Unintended Consequence

In her presentation slides, Williams noted that “an unintended consequence of increasing fee compression across the industry is that investors are comparing costs by focusing exclusively on a single data point — expense ratio. This can inadvertently de-prioritize other key factors such as risk and volatility, tax efficiency as well as impact on portfolio diversification.”

“Consumer impressions are more important than ever,” Williams said.

“The investment product with the lowest expense ratio doesn’t always have the lowest cost of ownership. Thorough due diligence for investors remains as important as it ever was to determine total cost of ownership,” she said, referring to slides in her presentation.

And she said fiduciary financial advisors have an instrumental role to play when working with the end client. Disclosure on its own is proving to be insufficient, she noted. “Advisors do face a challenge here but, in kind, it also is a tremendous opportunity,” she said. Advisors should be encouraged to “not shy away from difficult conversations” with clients, including about fee transparency and comprehension of investment costs.

“We want the consumer to have a solid understanding of how investment expenses compare … just as much as they need an understanding of an investment’s risk, volatility and impact on their portfolio diversification.”

—Brie Williams, SPDR Exchange Traded Funds

“We want the consumer to have a solid understanding of how investment expenses compare … just as much as they need an understanding of an investment’s risk, volatility and impact on their portfolio diversification.” Clients need “to have confidence they are not overpaying the returns in the largest part of their portfolio,” she added.

The Solution Is No Mystery

The Institute’s Knut Rostad began his presentation by emphasizing that “investor confusion over the fees they pay is no surprise; the solution is no mystery.” And he wants to change the paradigm implicit in the conversation about fees “that investors are the problem – they are at fault.” That perception becomes part of the “problem of how we move forward,” he added.

Rostad gave some historical perspective on how investors are educated and about the role of the Securities and Exchange Commission. Although, the SEC has disclosed financial information for Main Street investors since 1934, they are still very confused, he noted.

According to the landmark 2008 RAND Report on Investor and Industry Perceptions on Investment Advisors and Broker-Dealers, “many investors did not understand key distinctions” in the industry. “The roles are confusing.”

“Even after being presented with fact sheets, participants were confused by the different titles… common job titles are so similar that people can easily get confused over the type of professional with which they are dealing.”

Ten years later, a 2018 RAND Report on Investor Testing of Form CRS (Client Relationship Summary) showed that among 31 participants “some demonstrated significant misunderstandings” about IAs (investment advisors) and BDs (broker-dealers).

Additional Reading: Are You Really an FA?

Other findings from 2018: “CRS fails on fees due to vague ideas and unclear language.” On fees: “The fee section is ‘overwhelming’ and lacked ‘more specific details on fees.’”

The role of language is key to improving the understanding of fees.

Still Room for Improvement

On Sept. 22, the Institute presented another webinar on the issue, “Testing CRS, A Review of 29 Broker-Dealer Forms.” The Institute website said it “examines the broker-dealer and investment advisor CRS disclosures.”

Again hosted by Rostad, the Institute brought in language expert Deborah S. Bosley, Ph.D., founder of the Plain Language Group, to weigh in on the new CRS forms. The group works with business and government to provide content that is easy to read while also meeting regulatory requirements for plain language.

Based on her review of a random six of the 29 forms, Bosley saw room for improvement in both content and presentation: For example, investors are still faced with too much information, use of confusing financial terms and a lack of useful examples in the CRS forms. Meanwhile, not enough attention is given to presentation for ease of reading and absorbing the financial information, she noted. Sentences are long, paragraphs are thick, the voice is passive and the point size is too small to make the forms a comfortable read, especially for older investors.

“There is a lack of ease of understanding,” she said.

A Call to Action

The Institute also released a paper on Sept. 22, “The Case to Fix Form CRS Disclosure.”

It concludes: “Broker-dealers and investment advisers serve distinct and important roles in the capital markets. Industry marketing over decades has described very general similarities between BDs and IAs as their defining attributes. CRS reinforces these very general similarities. Industry marketing has helped engender roles and purposes. Form CRS falls short meeting its own stated objectives. CRS minimizes and obscures, or omits altogether, material information about their roles and purposes instead of highlighting it. This is why Form CRS needs to be fixed.”

However in his remarks during the webinar, Rostad put out a call to action: “The disclosure that we see right now from the CRS forms … is so terribly deficient that they can be improved. … In this regard the opportunities here for CRS … are in our view excellent in terms of actually serving a consumer’s purpose the way it is intended to.”

Patricia McDaniel is a freelance writer and editor and former journalist with Gannett’s New Jersey newspapers. She can be reached at pmcd5353@gmail.com.

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