The Strange Allure of Higher Fees

Just about anything that comes with the “alternative” label is automatically enticing to plenty of people. Alternative rock spoke to so many music fans that it became more or less mainstream in the 1990s. On a smaller scale, consider the people you know living alternative lifestyles, like the cousin in the nudist colony or your friend from high school who joined the Rainbow Family.

Alternatives of all sorts, with their capacity to shock, can feel fresh and new. But they can also lead people into behavior that is downright dumb. For evidence of that, consider the world of alternative mutual funds. This is the catchall phrase for funds that bet on whether mergers that companies have announced will actually happen; wager on some stocks to fall while others rise; swap stocks and bonds and commodities around the world as if it were a hedge fund; and employ other far-out investment strategies.

These alternatives are not necessarily dumb in and of themselves, but the way investors have picked these funds is baffling. The vast majority of money going into all mutual funds lands in funds with the lowest expenses, like index and exchange-traded funds. The reason? Simple math. If you have your money in two investments that both earn 8 percent before costs, and one charges you 0.25 percent while the other charges 1.5 percent, you keep more money with the cheaper one.

Read the rest of the article on The New York Times.