The No. 1 reason to buy index funds
I’ve been in love with index funds for a long time, especially for a reason that doesn’t get enough attention.
Lots of financial writers correctly praise index funds for their low costs, low turnover, low drama, massive and easy diversification, and numerous other attributes.
But today I’m going to repeat something I wrote in 2014: The No. 1 reason you should love index funds is they will keep you out of the hands of pushy, unethical salespeople and brokers.
If Wall Street knows you’re committed to index funds, you’ll probably drop to the bottom (where you want to be, I assure you) of cold-call lists used by security salespeople looking for business.
The reason is obvious: The paltry expenses paid by index-fund investors will never be enough to satisfy Wall Street’s seemingly insatiable need for hefty sales commissions, fancy offices, expense-paid trips, sky-high salaries and other perks.
Millions of investors seem willing to pay significant annual expenses for actively managed mutual funds.
In the very popular large-cap blend fund category, the average expense ratio is 0.98%. Index funds typically charge no more than one-fifth that much — and often less than 10% of that.
Even worse (in fact unconscionable) from Wall Street’s point of view, Fidelity Investments offers index funds in that category with no charge at all for expenses.
But what’s bad for Wall Street is good for investors.
In fact, there’s general agreement among academics and investment advisers who don’t sell products that the most reliable way to boost investment returns is to cut your expenses.
None of this is new, of course. But recently all this was practically shoved in my face by a news article about how systematic the scam artists have become. Salespeople often pretend to be our friends under the guise of a professional relationship, then turn around and do their best to screw us over for their own purposes.
In 2012, Richard Buck and I spelled all this out in a book called Get Smart or Get Screwed: How to Select the Best and Get the Most From Your Financial Advisor. The book is available free, and I recommend it.
I’m sad to report that things haven’t gotten better, as I learned from an article in Financial Planning magazine under this headline: “Advisor Who Touts His Holiday Giving Faces SEC Fraud Charges.”
The Securities and Exchange Commission alleged that the adviser, Keith Springer, most of whose clients are over 55, failed to tell those clients about millions of dollars in compensation he received for directing their investments into annuities and other high-cost products.
Springer’s Northern California radio show has a tagline that reads “Invest for need, not for greed.”
Yet his sales agents were heavily incentivized to sell high-cost annuities, for which they could win free trips, high commissions, and tickets to concerts and sports events. The more annuities they sold, the more benefits they received.
Now sure, I understand that salesmen should be paid for selling what they are paid to sell.
But Springer’s sales agents sold annuities, then somehow “discovered” that they could earn even more rewards by persuading clients to turn around and sell those annuities, incurring expensive surrender charges, so those same clients could buy new annuities. That, of course, generated new sales commissions.
Great for the sales agent. Toxic for the client. A textbook example of a conflict of interest.
Can you imagine somebody doing that to investors in index funds? I can’t either.
And speaking of conflict of interest, Springer’s firm never bothered to tell clients, as it should have, that the company was receiving much more compensation from annuities than if the clients had made other investments — or that the firm received kickbacks from a third-party portfolio manager.
What I’ve described so far could be called passive deception, failing to tell clients what they have a legal right to know.
But it’s worse than that. Think “active” deception.
You may have heard of “search engine optimization,” a process that involves finding the keywords that are likely to bring visitors to your website. This requires you to understand your target audience and what motivates them. Which seems relatively benign and positive.
But now investment companies, including Springer’s, have discovered a new kind of organized deception. It’s called “search engine suppression”. It’s the dark side of manipulating what you will see when you do an online search for a company or an adviser.
Here’s how it works: In the old days of the internet, I used to occasionally do a search for “pros and cons” related to one of the industry’s largest advisory firms, which spends tons of money on advertising, has lots of fans, but also thousands of detractors.
I would always find enough negative reviews to keep me reading for hours, if I wanted to. And of course I could find dozens of positive reviews apparently written by satisfied clients.
What’s different now is that I still get the gushing positive links but only a few negative ones from people complaining about relatively minor infractions like not returning phone calls reliably.
I have talked to enough clients of this firm to know it has not changed its business model or its practices. As it turns out, the firm seems to have hired one or more companies to “suppress” the bad things.
Suppression companies promise in their advertising that they will use “patented technology” to “bury” negative blogs, articles, legal links and bad press so they can be found only by scrolling through multiple pages of search results, far from the top hits.
Back to index funds.
Investors in index funds don’t have to worry about these tactics, because there are no lucrative sales commissions or fees to attract shady third-parties.
When you invest in index funds, you don’t have to monitor a fund manager or pay attention to the ups and downs of what analysts think of individual stocks. In fact, index funds are boring — and that’s a good thing for investors who want to adopt a strategy and then let it do its thing.
In my 2014 article “30 reasons to fall in love with index funds,” I described them as “the sleep-easy investment.”
I could write endlessly about the schemes that have been devised to take separate investors from their money. But if your money is in index funds, you won’t need to be concerned about all that.
For more on this topic, check out my podcast: “The number one reason to buy index funds.”
Richard Buck contributed to this article.
Paul Merriman and Richard Buck are the authors of We’re Talking Millions! 12 Simple Ways To Supercharge Your Retirement.