At Arm's Length - A Daily Market Commentary - Before the Bell Rings Financial Commentary about Money, Investing, and How It Affects the Average Investor

At Arm's Length: 12.23.04

Brokers on the Block

Christmas parties are usually populated with many of the same guests year to year. The problem is remembering conversations that may have been hampered by the season's spirits. Such was the case with a conversation I had recently with an elderly retiree who first chastised me for making him worry for most of 2004 and then asked me for a prediction for 2005. While my 2005 outlook is still in the making, I want to briefly speak about some of the things that are wrong with his portfolio, a private matter he willing bared for my perusal.

He told me that he retired with over $800,000 in stocks and pensions. This money he told me has been battered somewhat over the last three years but he was confident that it would recover enough to allow him to continue to draw $66,000 a year from those investments without out living his cash. Before I go too far, it is important to note two things: one, his savings is nearly 15 times that of the average retiree - are you listening Mr. Bush as you attempt to create retirement accounts out of Social Security? - and secondly, it was all invested using a broker.

Could he have done better investing this money on his own?

According to Harvard financial management professor Peter Turfano, Daniel Bergstresser of the Harvard Business School, John Chalmers of University of Oregon's Linquist College of Business who wrote a report titled "Assessing the Costs and Benefits of Brokers in the Mutual Fund Industry", the answer would be yes.

The paper's authors were quick to point out that the study was not designed to discredit buying mutual funds through brokers but rather to point out a performance issue that is related to broker sold funds. In fact, what they found surprised them. Mutual funds purchased through brokers lagged behind investor driven purchases by almost 2.30% without including the fees that accompany the funds sold by brokers. Add those sales charges and fees for the broker purchase into the mix and those returns drop even further.

Why would anyone look to a broker while adding to the cost of owning a fund which already comes with management fees and expenses? Probably because of the fear of making these decisions alone. Although the paper did include some 401(k) investments, the additional service that brokers provide may not be worth the cost even if the main reason is handholding or outsourcing, a reason cited by investors that were too busy to direct their own investments.

Here are some things to consider when buying through a broker.

Is the fund available directly from the company?
Is the fund tracked by popular monitoring companies such as Morningstar or Lipper?
Is the asset allocation provided by the broker offered fund better than a comparable fund generally available to the public?
Is the increased cost in expenses which might be higher than a comparable fund NOT including the broker's commission worth using the broker?

The paper did suggest that the psychological comfort provided by a broker may help you sleep better at night but the performance of that fund will not be noticeably better and may in fact be considerably worse.

The previous week's articles.

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