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Low-Cost Protection

Paul Merriman

I’VE BEEN IN LOVE with index funds for a long time, especially for a reason that doesn’t get enough attention. Lots of financial writers correctly praise index funds for their low costs, low turnover, low drama, massive and easy diversification, and numerous other good attributes.

But the No. 1 reason you should love index funds is they will keep you out of the hands of pushy, unethical financial salespeople. If Wall Street knows you’re committed to index funds, you’ll probably drop to the bottom—where you want to be, I assure you—of cold-call lists used by security salespeople looking for business.

The reason is obvious: The paltry expenses paid by index fund investors will never be enough to satisfy Wall Street’s seemingly insatiable need for hefty sales commissions, sky-high salaries, fancy offices, expense-paid trips and other perks.

Millions of investors seem willing to pay significant annual expenses for actively managed mutual funds. In the popular large-cap blend fund category, the average expense ratio is almost 1%. Index funds typically charge no more than one-fifth that much, and often less than 10% as much.

Even worse—in fact, unconscionable from Wall Street’s point of view—Fidelity Investments offers index funds in that category with no charge at all for expenses. But what’s bad for Wall Street is good for investors. In fact, there’s general agreement among academics and investment advisors who don’t sell products that the most reliable way to boost investment returns is to cut your expenses.

Salespeople often pretend to be our friends under the guise of a professional relationship, and then turn around and do their best to screw us over for their own purposes. Back in 2012, I coauthored a free book on the topic. Since then, things haven’t gotten better.

Consider a 2019 article in Financial Planning magazine under this headline: “Advisor Who Touts His Holiday Giving Faces SEC Fraud Charges.” The Securities and Exchange Commission alleged that the advisor, Keith Springer, most of whose clients are over age 55, failed to tell those clients about millions of dollars in compensation he received for directing their investments into annuities and other high-cost products.

Springer’s Northern California radio show has a tagline that reads “Invest for need, not for greed.” Yet his sales agents were heavily incentivized to sell high-cost annuities, for which they could win free trips, high commissions, and tickets to concerts and sports events. The more annuities they sold, the more benefits they received.

Springer denied the SEC’s charges. “The SEC wants to put us out of business for issues that were fixed long ago,” he wrote in an e-mail sent to MarketWatch. “I’m just an easy target for them. They know I don’t have the resources to fight them properly.”

Sure, I understand that salesmen should be paid for selling what they are paid to sell. But Springer’s sales agents sold annuities, then somehow discovered that they could earn even more rewards by persuading clients to turn around and sell those very annuities—incurring expensive surrender charges—so those same clients could buy new annuities. That, of course, generated new sales commissions.

Great for the sales agent. Toxic for the client. A textbook example of a conflict of interest. Can you imagine somebody doing that to investors in index funds? I can’t either.

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Speaking of conflict of interest, Springer’s firm never bothered to tell clients, as it should have, that it was receiving much more compensation from annuities than if the clients had made other investments. Or that the firm received kickbacks from a third-party portfolio manager.

So far, what I’ve described could be called passive deception—failing to tell clients what they have a legal right to know. But it’s worse than that. Think active deception.

You may have heard of “search engine optimization,” a process that involves finding the keywords that are likely to bring visitors to your website. This requires you to understand your target audience and what motivates them. That might seem relatively benign and positive.

But now investment companies, including Springer’s, have discovered a new kind of organized deception. It’s called search engine suppression. It’s the dark side of manipulating what you will see when you search for a company or an advisor online.

Here’s how it works: In the old days of the internet, I used to occasionally search for “pros and cons” related to one of the industry’s largest advisory firms, which spends tons of money on advertising and has lots of fans, but also thousands of detractors.

I would always find enough negative reviews to keep me reading for hours. Of course, I could also find dozens of positive reviews apparently written by satisfied clients.

What’s different now is that I still get the gushing positive links, but only a few negative ones from people complaining about relatively minor infractions like not returning phone calls reliably. I’ve talked to enough clients of this firm to know it hasn’t changed its business model or its practices. As it turns out, the firm seems to have hired one or more companies to suppress the negative reviews.

Suppression companies promise in their advertising that they will use “patented technology” to “bury” negative blogs, articles, legal links and bad press. Now such criticism can be found only by scrolling through multiple pages of search results, far from the top hits.

Investors in index funds don’t have to worry about these tactics because there are no lucrative sales commissions or fees to attract shady third parties. When you invest in index funds, you don’t have to monitor a fund manager or pay attention to the ups and downs of what analysts think of individual stocks. In fact, index funds are boring—and that’s a good thing for investors who want to adopt a strategy and then let it do its thing.

I like to describe index funds as “the sleep-easy investment.” I could write endlessly about the schemes that have been devised to separate investors from their money. But if your money is in index funds, you don’t need to be concerned about all that.

Paul Merriman runs PaulMerriman.com, a site dedicated to financial education. Richard Buck contributed to the above article. Paul and Richard are the authors of “We’re Talking Millions! 12 Simple Ways to Supercharge Your Retirement,” which is also available as a free PDF. Paul’s previous article was Be Suspicious.

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excel lent
excel lent
8 months ago

So a company like Edward Jones has no legitimate reason to exist?

Paul Merriman
Paul Merriman
8 months ago
Reply to  excel lent

Of course Edward Jones has a legitimate reason to exist. Our educational foundation is designed to give information to investors who wish to keep the extra costs of managing a fund in their own pocket rather than someone on Wall Street. We know that every additional .5% return can lead to an extra million dollars over a lifetime. With that in mind we want the do it yourself investor to capture that extra return. It is easy to do that. It means getting rid of loads, getting rid of high operating expenses, getting rid of turnover costs from active management, getting rid of extra taxes in taxable accounts and, for some, it means adding equity asset classes that have a very long history of paying a higher premium. The work we do is not focused on estate planning, tax planning, insurance planning and the many areas of help that a financial planner offers. We are only teachers, not advisors. But, when people need those kinds of help we are in favor of using hourly help as opposed to someone charging a percentage of the portfolio’s value. I do know from experience that the best result is likely to come from investors who are exposed to information that is totally in their best interest. I do not advocate information sources that offer advice without disclosing the long impact of their recommendations. Having said all that, if an investor is a good saver and uses an advisor who produces reasonable returns the investor will probably be okay. My hope is our advice will lead to an earlier retirement, living off more in retirement and leaving more to children and charities. I do this all without any compensation. Of course, bad free advice is not a bargain. It is up to the reader to make that judgement whether what we, or anyone else writes, is in their best interest. I encourage you to get a free copy of “We’re Talking Millions!” at paulmerriman.com/signup.

Peter Blanchette
Peter Blanchette
8 months ago

Thanks very much for coming to this site! Do you know, on a historical basis, whether market weight or equal weight index funds have done better? I do not think I have ever seen where market weight funds are actually offered. Are they pretty much the same? Thanks

Paul Merriman
Paul Merriman
8 months ago

I’m very happy to be working with Jonathan Clements. I consider him one of the “Truth-Tellers” in our industry. Here is what we expect from equal weighted index funds. Because the equal weighted portfolio has the same amount of money invested in each company, in periods when large growth companies make more than smaller companies, the market weighted index will do better. When smaller companies, or value companies, do better we would expect the equal weighted portfolio to do better. In the long run we expect small and value to make more than large and growth so we might expect the equal weighted portfolio to make more. But as we know from the last 93 years, there are lots of long periods of time where large growth does better than small value and investors with short term goals can become impatient. We recommend using different asset classes in building a portfolio rather than trying to get the right balance within one fund. Here is what we know over the last 90 plus years. A portfolio of 25% each S&P 500, large cap value, small cap blend and small cap value adds about 2% a year to the return with less volatility based on decade returns. These quilt charts tell the history beautifully.

Carl Book
Carl Book
8 months ago

I’ve never been comfortable with salespersons who acts like they are my friend. If they are offering a good service at an appropriate price, there is no need for the excessive friendliness. If they are not, I don’t want to be friendly. There is a good reason it is hard to find a fee only advisor. You can make way more money charging a percentage of assets.

Last edited 8 months ago by Carl Book
Paul Merriman
Paul Merriman
8 months ago
Reply to  Carl Book

Yes, finding a good hourly advisor is work. I am going to address the topic in a Zoom meeting on April 7. Do it yourself vs. private management is a huge decision, as is hourly vs. percentage of assets. Robo advisors serve a good role but I have strong beliefs about which ones are likely to produce the best returns. Here is a link to those who are interested. https://bainbridgecf.org/programs/public-education-programs

UofODuck
UofODuck
8 months ago

I shudder each time I hear of someone being pitched an annuity product. Annuities may have a place in certain financial plans, but they are not an investment. Yet, too many people think that the advertised annuity stream is “income,” rather than being made up largely of a return of their own capital. Upfront and ongoing fees in an annuity are also typically higher than what an investor would pay for an ordinary managed investment product (and significantly higher than an index fund). If someone manages to live beyond their normal life expectancy, great for them, but the only winners in this financial game are the companies selling these products.

Paul Merriman
Paul Merriman
8 months ago
Reply to  UofODuck

I agree with you in large part but there are cases where they make sense. For people who have under saved and are not appropriate for the stock market the single premium life annuity is a good choice. The challenge is getting the education to make the decision. Stan the Annuity Man offers a free library of books on the subject. Also, Stan and other suppliers offer the comparison of many different insurance companies without having to talk to a salesperson. https://www.stantheannuityman.com

Andrew Forsythe
Andrew Forsythe
8 months ago

Paul, thanks for an interesting article. I had never heard of “search engine suppression”, so I appreciate your highlighting that.

Paul Merriman
Paul Merriman
8 months ago

Hi Andrew, It was new to me too. But it explained why it was so hard to find the balance of good news and bad I expected to find in the case of some very controversial advisors.

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