Buying equity funds with the worst returns
Why do people still buy equity funds that give the worst returns? ‘They don’t know they’re doing it,’ answers Ole-Andreas Elvik Næss. Better information changes share purchases dramatically, a new study shows.
Ole-Andreas Elvik Næss is a postdoctoral fellow at the Centre for Applied Research at NHH.
On Thursday 29 September, Elvik Næss will be on stage at NHH's Alumni Conference in Oslo. He will explain the following:
Why do people still buy equity funds that give the worst returns?
CHOOSING THE MOST EXPENSIVE FUNDS – AND LOSING BIG
'How much can one lose in an active fund?’
'According to the Consumer Council, if you invested NOK 500,000 in active funds 20 years ago, you would have lost NOK 370,000 over the course of 20 years, compared to passive funds, also known as index funds. That’s a lot of money,’ says Elvik Næss.
Index funds are cheap, with low fees. They cost the customer less than 0.5 percent in annual fees. Active funds, where investors buy and sell shares with your money, have high fees. You pay up to two percent in fees over the course of a year. That can become very expensive.
Index funds and active funds perform about equally well, according to the Consumer Council.
‘It’s difficult to beat the market. On average, active funds don’t beat the index, they perform equally well, but the customer pays higher fees.’
STUDY OF ‘MISPERCEPTION’
Elvik Næss has researched why people buy equity funds that give the worst returns.
The study ‘Misperceived Returns to Active Investing: Evidence From a Field Experiment Among Retail Investors’ was carried out by Næss and Associate Professor Ingar Haaland at the Department of Economics.
‘We asked ourselves if people bought expensive funds because they were unaware that cheaper funds existed. That was the starting point for our study.’
Elvik Næss and Haaland conducted an experiment in which they give half of the participants, the ‘treatment group’, information that there are higher returns from index funds.
What happens to those who receive that information?
MASSIVE EFFECT
‘We see that they are greatly influenced by that information. It changes their views and they buy a lot more index funds. There is a 30 per cent increase in those who buy index funds, compared to the control group. The effect is massive, but it’s clear that many lack general financial knowledge,’ Elvik Næss explains.
'The banks will always recommend the more expensive funds. They profit the most from the expensive funds. They want customers to pay two percent of their money in annual fees. If you go to a bank and ask which fund you should invest in, you are often advised to purchase the expensive funds, not the cheaper ones.’
‘Would you say they have a reason to feel cheated?’
'In a way, but it depends which alternatives the customer wants. If the alternative is to put the money in a bank account, it is still better to invest in active funds. Customers do profit from it, but they could profit even more. They’re not given the best product, but not the worst either.’
‘So do some people think they can beat the market?’
‘Yes and we ask people about that in the study. There is always someone who thinks they can beat the market and invest in individual stocks, but once we inform them that, historically, even the best investors in Norway have not been able to beat the market, they often change their mind. It has a huge impact. When people get the facts, they quickly realise they can’t beat the market either,’ concludes the researcher.