Abstract

http://ssrn.com/abstract=2086766
 


 



Why Do Retail Investors Make Costly Mistakes? An Experiment on Mutual Fund Choice


Jill E. Fisch


Institute for Law and Economics, University of Pennsylvania Law School

Tess Wilkinson‐Ryan


University of Pennsylvania Law School

July 2013

ECGI - Law Working Paper No. 220
U of Penn, Inst for Law & Econ Research Paper No. 12-24

Abstract:     
There is mounting evidence that retail investors make predictable, costly investment mistakes, including underinvestment, naïve diversification, and payment of excessive fund fees. Over the past thirty-five years, however, participant-directed 401(k) plans have largely replaced professionally managed pension plans, requiring unsophisticated retail investors to navigate the financial markets themselves. Policy-makers have struggled with regulatory interventions designed to improve the quality of investment decisions without a clear understanding of the reasons for investor mistakes. Absent such an understanding, it is difficult to design effective regulatory responses. This article offers a first step in understanding the investor decision-making process. We use an internet-based experiment to disentangle possible explanations for inefficient investment decisions.

The experiment employs a simplified construct of an employee’s allocation among the options in a retirement plan coupled with technology that enables us to collect data on the specific information that investors choose to view. In addition to collecting general information about the process by which investors choose among mutual fund options, we employ an experimental manipulation to test the effect of an instruction on the importance of mutual fund fees. Pairing this instruction with simplified fee disclosure allows us to distinguish between motivation-limits and cognition-limits as explanations for the widespread findings that investors ignore fees in their investment decisions.

Our results offer partial but limited grounds for optimism. On the one hand, within our simplified experimental construct, our subjects allocated more money, on average, to higher value funds. Furthermore, subjects who received the fees instruction paid closer attention
to mutual fund fees and allocated their investments into funds with lower fees. On the other hand, the effects of even a blunt fees instruction were limited, and investors were unable to identify and avoid clearly inferior fund options. In addition, our results suggest that excessive, naïve diversification strategies are driving many investment decisions. Although our findings are preliminary, they suggest valuable avenues for future research and important implications for regulation of retail investing.

Number of Pages in PDF File: 53

Keywords: Securities, mutual fund fees, expenses, expense fees of mutual funds, expense ratio, management fees, 12b-1 fees, advisory fees, sales loads, performance, costs, operating expenses, investor behavior, investor returns, empirical research, behavioral decision research, biases, transparency

JEL Classification: D83, G14, G23, G28, K22

working papers series


Download This Paper

Date posted: June 18, 2012 ; Last revised: July 31, 2013

Suggested Citation

Fisch, Jill E. and Wilkinson‐Ryan, Tess, Why Do Retail Investors Make Costly Mistakes? An Experiment on Mutual Fund Choice (July 2013). ECGI - Law Working Paper No. 220; U of Penn, Inst for Law & Econ Research Paper No. 12-24. Available at SSRN: http://ssrn.com/abstract=2086766 or http://dx.doi.org/10.2139/ssrn.2086766

Contact Information

Jill E. Fisch
Institute for Law and Economics, University of Pennsylvania Law School ( email )
3501 Sansom Street
Philadelphia, PA 19104
United States
215-746-3454 (Phone)
215-573-2025 (Fax)
Tess Wilkinson-Ryan (Contact Author)
University of Pennsylvania Law School ( email )
3501 Sansom Street
Philadelphia, PA 19104
United States
Feedback to SSRN


Paper statistics
Abstract Views: 1,364
Downloads: 351
Download Rank: 45,378

© 2014 Social Science Electronic Publishing, Inc. All Rights Reserved.  FAQ   Terms of Use   Privacy Policy   Copyright   Contact Us
This page was processed by apollo7 in 0.422 seconds