Morningstar Magazine - June/July 2018 - 23

Dispatches

Do Investors Really
Pay Attention to Fees?
Two studies cast doubt,
highlighting need
for industry to lead
the way.
BEHAVIORAL INSIGHTS

Stephen Wendel

Two new papers on fees and investor behavior-
one by Morningstar and the National Opinion
Research Center at the University of Chicago and
the other by the Financial Conduct Authority
of the United Kingdom-can help us understand
how investors respond to investment fees.
In both reports, the authors find that individual
investors partially ignore the fees they are paying,
with potentially serious consequences. By
changing the way in which investments are
presented and chosen, however, investors would
be more likely to take fees into account. Let's
take a quick look at the findings from each paper
and examine what they mean, especially in
light of our research that finds that the average
asset-weighted fees paid by investors in the United
States are declining.

were broadly the same, except for cost. The
researchers then studied how much the
participants invested in the higher-cost funds
versus the lower-cost ones, depending
on how the fees were presented.
Even with a clear presentation of fees, 27.2%
of the time investors selected the higher-cost, but
otherwise equivalent, fund. However, when
the researchers provided an additional warning
prompt to investors, reminding them to go
back to the information provided and review the
fees of each fund, the selection of higher-cost
funds decreased by 6.2 percentage points. When
they reminded investors and offered fee data
directly next to the reminder (making it even easier
to compare fees), that decreased the selection
of higher-cost funds by 10.5 percentage points-
a statistically, and practically, significant result.

cents instead of percentage points, displaying
performance as annual versus cumulative numbers,
and changing the allocation process from
"invest as you like" to "select one ETF for all of your
money." The first two showed no statistically
significant impact on people's investment choices.
The last one did. It decreased the amount
of money going to the most expensive ETF by 7
percentage points.
Wait a Minute...

These two papers are interesting because
they come amid broader trends in the United
States toward lower fees. According to
Morningstar's latest study on fees, since 2000,
the average asset-weighted fees paid
by investors of actively managed funds have
dropped by more than one fourth, and
the average asset-weighted fees of passive
funds have dropped by 10 basis points.2

Morningstar's Work on Investor Behavior and Fees

Now You See It (and Apparently, Now They Don't)

"Why Do People Invest in Overpriced Index Funds,
and Can Behavioral Nudges Help?" is a joint
work between Ray Sin and Ryan Murphy of
Morningstar's behavioral science team and Angela
Fontes and Mark Lush of NORC at the University
of Chicago. (The paper is available at http://
www.morningstar.com/learn/fees.) It attacks the
same question-how investors respond
to fees-from a different angle. A nationally
representative sample of more than 3,000
Americans were given a hypothetical $10,000 and
a choice to invest among three identical
exchange-traded funds tracking the S&P 500. The
funds differed only in price. (Their names
were masked to avoid extraneous signals.) They
cost 0.04%, 0.09%, and 0.4%.

How can these findings coexist? Asset-weighted
fees are decreasing, yet investors seem to partially
ignore fees at the individual level? Both can
be true because numerous factors could cause the
aggregate decline. Is it caused by individual
investors making thoughtful choices based on
a careful analysis of fees and value? Or is it
a consequence of competition and the broader
move to passive (and generally lower-cost)
investments? Or perhaps it is the result of major
institutional investors driving down costs?
We have good reason to doubt that everyday retail
investors are solely responsible for driving
these trends, which leads to important lessons for
public policy regarding how investments are
presented to retail investors.

In April, the FCA released a paper by Lucy Hayes,
William Lee, and Anish Thakrar titled "Now
You See It: Drawing Attention to Charges in the
Asset Management Industry."1 The paper presents
an online experiment with 1,000 unadvised
individual investors in the U.K. The participants
used a simulated investment platform to
select among actively managed U.K. equity funds.
The researchers selected pairs of funds that

The optimal financial choice, naturally, would
be to invest all of one's money in the cheapest
fund. But as with the FCA study, that did
not happen. Instead, only 42% of the money went
to the cheapest ETF, while 27% went to the
most expensive fund. We tested three different
interventions to nudge investors to be more
sensitive to fees: displaying fees in dollars and

To better understand this research and
its implications, let's dive deeper into the new
Morningstar report on investor behavior.
How the Morningstar Study Worked

In the paper by Morningstar and NORC,
we presented a randomized experiment with
a nationally representative sample of

1 https://www.fca.org.uk/publications/occasional-papers/occasional-paper-no-32-now-you-see-it-drawing-attention-charges-asset-management-industry
2 Oey, P. 2018. "U.S. Fund Fee Study: Average Fund Fees Paid by Investors Decreased 8% in 2017, the Largest One-Year Decline Ever." Morningstar white paper: https://www.morningstar.com/lp/
annual-us-fund-fee-study.

global.morningstar.com/Morningstarmagazine

http://www.morningstar.com/learn/fees http://www.morningstar.com/learn/fees https://www.fca.org.uk/publications/occasional-papers/occasional-paper-no-32-now-you-see-it-drawing-attention-charges-asset-management-industry https://www.morningstar.com/lp/annual-us-fund-fee-study https://www.morningstar.com/lp/annual-us-fund-fee-study http://global.morningstar.com/Morningstarmagazine

Table of Contents for the Digital Edition of Morningstar Magazine - June/July 2018