Saturday, April 15, 2006

The Ownership Society is not a good deal

Republicans like to talk a lot about the ownership society, one in which every person is responsiible for his fate and his ultimate outcomes. What most of them really mean is that they think they're smarter than everyone else and won't get hit by bad luck, poor choice of parents, or a lying, cheating CEO who took all the money and ran. What they forget is that we live in a country where most of the folks can barely be trusted to drive like a decent human being, and trusting those sorts of people to make financial decisions is like trusting me to know how to dress for a wedding: the outcome will not be good.

Now, the New York Times has reported a study that shows even top-achieving students in MBA programs cannot be trusted to make good decisions when it comes to allocating money to a selection of index funds! They chose on average, higher fee funds (i.e., got themselves cheated), and were easily fooled by carefully selected data. This is why privatizing social security is a bad idea, and why typical investors do extremely badly in their 401(k) plans, even assuming that they aren't just getting the shaft by their plan administrator.

The rational response, the professors argue, would have been to allocate all the money to the fund with the lowest fees. Yet fewer than 20 percent of either group of students did so. As a result, the hypothetical portfolios built by most of the students paid much higher fees than were necessary: 1.22 percentage points more, on average, among the undergraduates and 1.12 points higher among the M.B.A. students...

...if a sampling of elite students can't separate the wheat from the chaff in assessing mutual fund reports, most investors probably can't do so, either. (All the study participants were high academic achievers who had scored above average on a financial literacy test administered by the professors.)

In the other additional test, another group of 114 students was given a one-page sheet that, instead of reporting returns since inception, specifically compared the funds' fees. Students in this final group did, on average, construct portfolios with lower fees. Nevertheless, even this group came nowhere close to allocating its entire portfolio to the low-cost fund. More than half of these students, in fact, continued to allocate some money to the higher-cost index funds.

WHAT conclusions emerge from all these tests? Over all, the study said, the results do "not inspire optimism about the financial choices made by most households."
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