Data & Research December 6, 2007

Brokers Aren't Boosting Returns, Study Says

Investors in loaded mutual funds underperform their own funds' reported returns by three times as much as no-load fund investors even though the load investors are paying for brokers to help them, according to a new study.
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A news release from the Zero Alpha Group (ZAG) said fund investors in all three principal load-carrying retail share classes (A, B, and C) experience worse timing than investors in no-load funds and no-load index funds. That means, the study asserted, that investors in load funds actually suffer more when it comes to timing. Among A,B, and C class funds, “Class B investors suffer from the poorest cash flow timing, underperforming a buy-and-hold strategy by 2.28 percentage points annually, compared with annual underperformance of 0.78 percentage points for investors in pure no-load funds,’ the fund says.

The study concludes: “We find that investors who transact through investment professionals using conventional distribution arrangements experience substantially poorer timing performance than investors who purchase pure no-load funds…. No-load index funds are the only funds found to show no evidence of poor investor timing.”

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The announcement said that the actual performance experienced by fund shareholders differs substantially from the performance of the funds in which they invest because of the timing of investor cash flows.

“Investors pay fees to brokers expecting to receive good financial advice, but mounting evidence suggests that many are worse off as a result,’ contended Mercer Bullard, study co-author, founder and president, Fund Democracy, and securities law professor, University of Mississippi School of Law. “Investors’ actual performance has long lagged the performance of mutual funds in which they invest, yet paying for advice from brokers may increase rather than decrease this performance gap. Perhaps brokers shouldn’t always be expected to put you in the fund with the best investment performance, but at least they should get you the returns of the fund they put you in.”

The press release said the study found that:

  • Investors in active funds suffer more than three times the annual underperformance of index fund investors; 1.7% versus 0.47%. Investors in no-load index funds suffer no performance gap, however.
  • Investors in load funds and legal no-load funds (funds with no load and a low 12b-1 fee) experience annual returns that lag the performance of the funds in which they invest by 1.82% and 1.91% respectively. Among all load funds, Class B investors suffer from the poorest cash flow timing, underperforming a buy-and-hold strategy by 2.28% annually. In comparison, investors in pure no-load funds (funds with no commission and no 12b-1 fee) experience an annual performance gap of 0.78%.

Entitled “Investor Timing and Fund Distribution Channels,” the ZAG-sponsored study is co-authored by Bullard; Geoff Friesen, assistant professor of finance, College of Business, University of Nebraska-Lincoln, Lincoln, Nebraska.; and Travis Sapp, assistant professor of finance, College of Business, Iowa State University, Ames, Iowa.

More information is available at http://www.zeroalphagroup.com

Data & Research December 6, 2007

Advisers Help Parents Save for College Costs

Families with college-bound children who work with a financial adviser are on their way to being able to pay 47% of their college costs – significantly better than the parents of college-age children in general who will going to be able to pay an estimated 24%, a new Fidelity Investments study has found.
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A Fidelity news release about its first College Savings Indicator said the estimates were based on the current college cost projections of more than $100,000 for today’s high school seniors, including tuition, fees, and room & board.

529 Plan Usage

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Faring better than parents in general are those parents utilizing a 529 plan, who are on track to cover 52% of their children’s college expenses, according to Fidelity. According to the announcement, among those in a 529 college savings plan, 40% opened their account through an adviser. Only 5% of families using an adviser believe they will not meet their college savings goal.

“Advisers are not only helping parents to create a solid savings strategy for future college expenses, but they’re also helping them to feel more confident that they can actually meet their goals, despite what may seem at first like a daunting sum of money to be saved,” said Martha B. Willis, executive vice president, Fidelity Investments Institutional Services. “Regardless of whether families utilize an adviser or save on their own, it is critical that they practice good savings habits, such as starting early, investing regularly, and utilizing tax-advantaged accounts such as 529s that can help their savings stretch further.”

As part of the study, Fidelity conducted a nationwide survey of parents with college-bound children of all ages. Parents provided data on their current and projected household asset levels including college savings, use of an investment adviser, and general expectations and attitudes towards financing their children’s college expenses. Using Fidelity’s proprietary asset-liability modeling engine, the firm was able to calculate future college savings levels per household against anticipated college costs.

“Parents who do not have a solid college savings strategy or who are not utilizing a tax-advantaged savings account, such as a 529 plan, may see their child having to rely more heavily on student loans or other means to supplement costs,’ said Carolyn Clancy, executive vice president, Fidelity Personal and Workplace Investing.

Other Funding Sources

When asked how they expect to meet anticipated college costs, parents predict they will directly fund 27% through general savings and dedicated college savings accounts and an additional 16% from income they will earn while their child is in school.

Parents surveyed said they anticipate 18% of the total college cost of college will be covered by student loans, a potentially sizeable burden. For example, using the $100,000 average college cost, and assuming an average 10-year repayment period with an interest rate of 7.5%, the total cost of the loan could exceed $25,000.

Parents also expect their children to fund about one-quarter (26%) of the total cost of their college education through a combination of their own savings, income from working while in school and student loans. As a matter of fact, over three-quarters (79%) of the parents believe their children would appreciate college more if they shared the responsibility of paying for it.

Scholarships and grants are expected to cover 20% of expenses, according to parents, while the remaining 11% of costs would come from other sources like personal loans and gifts.

More than half (53%) of parents surveyed expressed concern that financial constraints will impact their children’s educational choices. Parents with older children (ages 13-18) report they are re-evaluating their savings strategies to meet projected costs. Of this group, 32% are considering having their child live at home, one-quarter are weighing the costs of public versus private colleges, and 22% have cut back on spending to save more.

Data for the Indicator (number of children in household, time to matriculation, school type, current savings and expected future contributions) are collected by Research Data Technology, an independent research firm, through a national online survey of almost 2,300 parents nationwide with children aged 18 and younger who are expected to attend college; with household incomes of $30,000 a year or more; and are the financial decisionmakers in their household.

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