Calling someone cheap is not often a term of endearment, but it has become exactly that in the investment industry.
According to Morningstar, more than 95 percent of all U.S. retail investments made since 2005 were in the cheapest 20 percent of products in the market. Responding to that trend, average retail investment management prices have dropped nearly every year since then. Now everyone wants to be heralded as cut-rate and discounted.
But just like being cheap can lead people to buy washing machines and cars that break down more often, bargain-basement financial solutions can also be costlier in the long term.
The reason is, the cost of an investment product or service can be much more than the sticker price alone.
For starters, investors should make sure that investment solutions that take a bare-bones approach to keep costs down are accurately investing their money. In a survey of more than 50 different low-fee retirement solutions, for instance, we found that nearly all of them did not consider a client’s income or other investments held by competitors as playing an important role in designing an investment portfolio.
That means these products can mis-invest their client’s money, either by exposing their client’s to too much risk, potentially subjecting them to costly investment losses, or too little risk in the market, which would possibly limit investment gains for their clients (and their solution providers).
It’s akin to a doctor prescribing medicine without first considering other prescriptions a patient is taking, an ignorance that can be costly for patients and investors alike.
Similarly, investors should be mindful of the tax implications of the investment products they use. The tax code is full of guidance about depositing, trading and withdrawing investment money, which can unnecessarily drive up clients’ tax bills when ignored in a cheap, no-frills approach.
“It’s time to relegate cheap to the same meaning it holds in other industries.”