This Day On The Street
Continue to site right-arrow
ADVERTISEMENT
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here
Stocks Under $10 with 50-100% upside potential - 14 days FREE!

Why Advisers Are Recommending Index Funds

Stocks in this article: VFINX

NEW YORK ( TheStreet) -- Investors have been abandoning actively managed mutual funds, which aim to outdo market benchmarks. Since 2008, shareholders have pulled $393 billion from active large-cap U.S. stock funds, according to Morningstar. At the same time, large-cap index funds reported $218 billion in inflows.

Part of the reason for the exodus from active managers could be that investors think index funds will outperform. But much of the move into passive funds is due to dramatic changes in the compensation system of financial advisers. These days advisers have a motivation to recommend index funds. That is very different from the past, when financial advisers had incentives to stick with active funds. The shift in compensation has had a big impact because half of all fund investors use a financial adviser, according to the Investment Company Institute, the mutual fund trade group.


As recently as two decades ago, the big majority of advisers were paid every time a client bought a stock or mutual fund. When they sold funds, advisers received a commission known as a load. A typical fund would charge an up-front load of 5%. So when a client spent $10,000, $500 went to the broker, and only $9,500 was invested in mutual fund shares.

Under the commission system, the adviser had a clear incentive to recommend funds that came with the biggest loads. In most cases, funds with sizable loads were actively managed.

The advisers had no incentive to sell funds that came without loads. In most cases, the no-load funds were designed to serve do-it-yourself investors who did not use advisers. Index funds from Vanguard and other companies typically came with little or no loads, so they were largely ignored by advisers.


In the 1990s, critics began to attack the use of loads. In the load system, advisers were rewarded for trading rapidly because each new purchase generated a commission. The critics said that the commission system caused advisers to focus on their own incomes -- not on what was best for the clients. Gradually many brokers came to agree. Instead of charging a commission for each transaction, more advisers began imposing flat annual fees that equaled 1% or so of a client's total portfolio.

1 of 2

Select the service that is right for you!

COMPARE ALL SERVICES
Action Alerts PLUS
Try it NOW

Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
  • Weekly roundups
TheStreet Quant Ratings
Try it NOW
Only $49.95/yr

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
  • Upgrade/downgrade alerts
Stocks Under $10
Try it NOW

David Peltier, uncovers low dollar stocks with extraordinary upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
  • Weekly roundups
Dividend Stock Advisor
Try it NOW

Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Alerts when market news affect the portfolio
  • Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
Real Money Pro
Try it NOW

All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.

Product Features:
  • Real Money + Doug Kass Plus 15 more Wall Street Pros
  • Intraday commentary & news
  • Ultra-actionable trading ideas
Options Profits
Try it NOW

Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

Product Features:
  • 100+ monthly options trading ideas
  • Actionable options commentary & news
  • Real-time trading community
  • Options TV
To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
Submit an article to us!

Markets

DOW 17,778.15 +421.28 2.43%
S&P 500 2,061.23 +48.34 2.40%
NASDAQ 4,748.3960 +104.0840 2.24%

Brokerage Partners

Rates from Bankrate.com

  • Mortgage
  • Credit Cards
  • Auto

Free Newsletters from TheStreet

My Subscriptions:

After the Bell

Before the Bell

Booyah! Newsletter

Midday Bell

TheStreet Top 10 Stories

Winners & Losers

Register for Newsletters
Top Rated Stocks Top Rated Funds Top Rated ETFs