Why Does Mutual Fund Advertising Work? Some Complementary Evidence

Abstract

The basic question that this article addresses is: Why does mutual fund advertising work? The summation of external evidence is compatible with evidence that greater mutual fund advertising attracts investors with below-average financial literacy who find the investment decision process overwhelming:

1. Investor levels of financial literacy predict differences in investment behavior.

2. Investors with below-average financial literacy are overwhelmed by information overload in the investment process and opt out.

3. Investors with below-average financial literacy make non- normative “revealed preference” choices that include passive investment, avoidance of investment complexity, and decisions based on limited experience.

4. Investors with below-average financial literacy are attracted to funds (increased flow) that come to their attention through greater fund advertising.

5. Investors with below-average financial literacy favor broker-sold funds, which underperform direct-sold funds even on a pre-distribution fee basis.

6. Broker-sold funds with larger front-end loads and distribution fees provide agency incentives for brokers to sell higher-cost and lower-performing funds for their own benefit.

7. Funds sold through selected superior financial advisors are to be favored over broker-sold funds due to higher standards of legal performance, higher quality and range of services, lower-cost and higher-performing funds, and “fee only” charges.

Keywords: mutual funds, advertising, financial literacy, information overload, revealed preferences, broker-sold funds, performance, distribution fees, agency, financial advisors, fee-only advisors

JEL Classification: G2, G23, G28