Every significant advancement in the mutual fund business has been met with a common refrain: “Investors will hurt themselves with this.”
It makes for interesting talk, but there is ample proof that it’s not true, and that it never has been.
Some recent studies and a milestone in industry development show that ordinary fund investors are smarter than most industry skeptics give them credit for.
That won’t shut up the skeptics when the next great development comes along, but it does show that consumers have been able to adapt to beneficial changes without suffering unfortunate consequences.
Consider some of the developments that were supposed to have bad side effects for average investors:
• The evolution of retirement plans allowing for daily account pricing – rather than weekly, monthly or quarterly pricing – was purportedly going to turn a generation of retirement savers into wild-eyed day traders. While some investors did take advantage of the flexibility to use trading strategies in their retirement-savings accounts, average investors stuck with long-term strategies while enjoying better day-to-day account information.
• The development of mutual-fund “supermarkets” run by companies such as Schwab and Fidelity allowed investors to access multiple fund companies on one platform, instead of dealing individually with each firm. Naysayers suggested that it would create a generation of investors who flitted from one fund to the next, trading into what’s hot in a vain attempt to surf the performance charts.
Schwab’s OneSource celebrates its 20th anniversary this month, and it is safe to say that the fund supermarket evolution created a generation of investors that was more cost-conscious and quality-aware than the one before it.
Prior to OneSource and its eventual competition, every fund firm seemingly had an offering in every asset class, allowing investors to diversify within one fund group. That meant a lot of good fund companies expanded into areas where they lacked expertise.
After OneSource – which made it easy for investors and their advisers to seek the best in breed for each asset class – a lot of needless funds were shuttered. Not only did the supermarket platforms give fund firms the impetus to stick to what they do best, but investors who bought those best-in-breed funds did not trade wildly into and out of them.
• The evolution of exchange-traded funds – which trade minute-by-minute like stocks instead of at the daily closing price like traditional funds – has made a raft of new investment products possible.
The expected fallout, however, was that investors would trade themselves into oblivion, destroying the long-term benefits that come from holding most of the indexes that ETFs are based on. Critics point to average holding periods for ETFs to suggest it’s happening.
A new study titled “ETFs: For the better or bettor?” conducted by the Vanguard Group shows that average ETF investors are not ruining their portfolios with reckless trading. Joel Dickson, one of the study’s authors and a principal in Vanguard’s Investment Strategy Group, noted that critics’ presumptions about ETF trading are based on turnover data dominated by institutional traders making a gazillion computer program trades, but does not reflect individual investors. Vanguard analyzed more than 3.2 million transactions in more than 500,000 positions held in traditional mutual fund and ETF share classes of four different Vanguard index funds from 2007 through 2011, and the results showed that even in the most pressure-packed of times – like the May 2010 “Flash Crash” – “claims of speculative trading behavior by ETF investors just were not supported by the data,” Dickson said.
“Generally, investors tend to be consistent animals over time,” he said. “While the tools may develop and evolve, ultimately the actions that are observed are not the worst behaviors made possible by the new products and services. People may assume the worst of investors, but it’s not how it actually happens.”
That’s good news for average investors because it means they are adopting evolutionary products the right way, waiting to understand them and to know how they fit in with long-term investment plans before joining the movement.
“The knee-jerk reaction to almost all of the advances we have seen has been ‘Oh my goodness, what is going to happen to the industry?’ and ‘Investors will blow themselves up with this,’” said Geoff Bobroff of Bobroff Consulting, a leading industry observer. “Surprise, surprise, the world hasn’t come to an end yet and, in fact, the fund world has gotten better for each of these developments.
“Joe Six-pack is going to do exactly what he has always done,” Bobroff added. “He is not going to change, just because the technology exists for him to do something different. He will adapt, and over time become comfortable with the newer products and newer ways. That doesn’t mean he will always make money; the market won’t always work for Joe Six-pack, but that won’t be because the fund industry is evolving, it will be because that’s just what the way the market is sometimes.”Chuck Jaffe is senior columnist for MarketWatch. He can be reached at firstname.lastname@example.org or at P.O. Box 70, Cohasset, MA 02025-0070.