Investors who overestimate their financial acumen pay higher fees, Finra says

There's a difference in the investing world between thinking you know something and actually knowing it, with the former linked to paying higher investment fees, according to a study published Friday by the Finra Foundation.

The research, based on data from the group’s 2018 and 2021 National Financial Capability studies, found an inverse correlation between financial aptitude and fees. The better people scored on a 10-question test about investment scenarios, the more likely they were to pay lower fees.

Conversely, the higher that they rated their own levels of financial knowledge, the more likely they were to pay higher fees, Finra found.

Those who got an average of 5.7 of 10 questions correct on the test reported paying investment fees of less than 0.5%. As the number of correct answers went down, the fees they said they paid increased, with those having answered an average of 3.65 questions right reporting fees of 4% or higher, according to Finra.

Meanwhile, those who rated their knowledge at 4.96 out of 7 reported paying the lowest level of fees, at under 0.5%, compared with people who rated themselves at 5.43, who said they were paying 4% or more.

“Our findings reveal that investors with higher levels of objectively measured investing knowledge report paying lower fees relative to those with lower levels of objectively measured investing knowledge. However, investors with higher self-assessed investing knowledge tend to pay higher fees than those with lower self-assessed investing knowledge,” the report noted. “These results underscore the importance of bolstering investing knowledge and addressing potential overestimations in investors’ perceived knowledge.”

The data in the study include responses from more than 4,800 people who have investments beyond assets in retirement accounts.

An important caveat is that some of the investors who had lower scores on the 10-question test likely miscalculated the investment fees they paid, the authors wrote.

“Fee transparency is one of many factors that support investors’ ability to make well-informed decisions about their investments. However, research indicates that when presented with a summary prospectus, investors tend to focus primarily on returns … often overlooking the impact of fees on their overall portfolio performance,” the report stated.

Therefore, using fee comparison tools for mutual funds, ETFs and other investments that also take performance into account is beneficial, the authors wrote. “Further, encouraging conversations about fees and costs between a financial professional and their clients is also important.”