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The Index Fund Rationality Paradox

46 Pages Posted: 22 Mar 2005 Last revised: 4 Jan 2010

Gjergji Cici

College of William and Mary - Mason School of Business

Michael D. Boldin

Wharton Research Data Services

Date Written: June 16, 2009

Abstract

Mutual funds that track the S&P 500 are popular because they have significantly lower costs than the average, actively-managed equity fund. However, a measurable number of investors select index funds with excessive fees and uncompetitive returns. We call this observation the Index Fund Rationality Paradox because it conflicts with the belief that index fund investors are making a rational, low-cost choice in their ‘type of fund’ decision. In our analysis of this paradox, we find that both retail and institutional index investors tended to make better choices in recent years, but the cost of poor choices among both groups continues to be significant. In fact, we are able to identify an arguably naïve group of retail investors that seem to be unduly influenced by brokers and financial advisors. These investors are largely responsible for the remaining paradox.

Keywords: Mutual funds, S&P 500 index

JEL Classification: G20

Suggested Citation

Cici, Gjergji and Boldin, Michael D., The Index Fund Rationality Paradox (June 16, 2009). Journal of Banking and Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1007580

Gjergji Cici (Contact Author)

College of William and Mary - Mason School of Business ( email )

P.O. Box 8795
Williamsburg, VA 23187-8795
United States
757-221-1826 (Phone)

Michael D. Boldin

Wharton Research Data Services ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States
215-573-0897 (Phone)

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