Overconfidence may not be helping investors’ wallets, according to a report from the Financial Industry Regulatory Authority’s education foundation. The agency found that investors who think they know more actually end up paying higher fees.
However, those who have actually demonstrated higher investing knowledge through testing ended up paying lower fees than those who scored lower.
“Our analyses indicate that investors with higher levels of objectively measured investing knowledge reported paying lower fees, while those who have higher levels of self-assessed investing knowledge reported paying higher fees,” said the report, released by the Finra Investor Education Foundation in early October.
On average, investors who rated their investing knowledge at 5.43 on a scale of 1.0 to 7.0 paid 4% or more in fees, while those who rated their investing knowledge at a lower level paid less. Those who put their knowledge at an average level of 4.96, for example, reported paying fees of under 0.5%.
“This new study gives us even more evidence that bolstering investing knowledge, while also helping investors understand the potential limits of their knowledge, is vital to improving investors’ outcomes,” says Gerri Walsh, the foundation’s president. “As the financial landscape becomes more complex with product offerings and investment choices, it remains important for investors to understand the relationship between fees and returns.”
The researchers noted that it’s possible investors may in some cases not be aware of the true fees they are paying. “Since the fees are self-reported, it is possible that investors with lower objective investing knowledge are not actually paying higher fees but are simply miscalculating/misestimating the fees paid,” the report said.
As a result, investors with high self-assessed investing knowledge may be more inclined to pay higher fees, even though investment performance has been linked to lower loads and expense ratios, researchers said.
In addition, some investors may knowingly pay higher fees for reasons of their own, such as the desire to work with a specific financial professional or for a specific risk-reward trade-off, Finra said.
According to research, when investors are shown summary prospectuses about their investments they tend to focus on returns. The Finra researchers suggested that firms encourage their advisors “to use tools that easily compare and analyze the costs and potential returns of various mutual funds, ETFs, and other investment options, while taking into account the impact of fees on overall portfolio performance.”
One useful tool is the Form CRS, which can prompt a discussion about how fees and costs will affect performance. One question investors might ask advisors: “If I give you $10,000 to invest, how much will go to fees and costs, and how much will be invested for me?