Financial Literacy, the “High-Fee Puzzle,” and Knowledge about the Importance of Fees

Abstract

This article investigates the causes of the “high-fee puzzle,” which is that some people pay high-fees for financial advice and financial products when lower-fee advice and products are available. We hypothesize that lack of awareness of the size of the effect of fees on account balances is one cause. We survey college students with business-related majors, asking them questions on the effects of fees on account balances, as well as standard financial literacy questions. We find that only one-third of students are able to answer the fee questions correctly; three-quarters correctly answered the common financial literacy questions. We tested whether people understand the importance of fees when fees are presented in a simple, transparent manner. Our results suggest that policies to require simple, transparent fee disclosures may be more effective if more people understood the importance of fees. For pension participants, our results suggest the importance of investment menus excluding high-fee options and focusing on low-fee options.

TOPIC: Retirement

Key Findings

• ▪ We find widespread lack of knowledge concerning the size of the effect of fees on future account balances.

• ▪ This lack of knowledge may explain the “high-fee puzzle,” where people pay high-fees for financial products and advice when lower-fee alternatives are available.

• ▪ For pension participants, our results support the importance of investment menus excluding high-fee options and focusing on low-fee options.