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

49 Pages Posted: 18 Jun 2012 Last revised: 27 Oct 2018

See all articles by Jill E. Fisch

Jill E. Fisch

University of Pennsylvania Carey Law School; European Corporate Governance Institute (ECGI)

Tess Wilkinson‐Ryan

University of Pennsylvania Carey Law School

Date Written: 2014


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.

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

Suggested Citation

Fisch, Jill E. and Wilkinson-Ryan, Tess, Why Do Retail Investors Make Costly Mistakes? An Experiment on Mutual Fund Choice (2014). University of Pennsylvania Law Review, Vol. 162, P. 605, 2014, European Corporate Governance Institute (ECGI) - Law Working Paper No. 220/2013, U of Penn, Inst for Law & Econ Research Paper No. 12-24, Available at SSRN: https://ssrn.com/abstract=2086766 or http://dx.doi.org/10.2139/ssrn.2086766

Jill E. Fisch

University of Pennsylvania Carey Law School ( email )

3501 Sansom Street
Philadelphia, PA 19104
United States
215-746-3454 (Phone)
215-573-2025 (Fax)

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels

Tess Wilkinson-Ryan (Contact Author)

University of Pennsylvania Carey Law School ( email )

3501 Sansom Street
Philadelphia, PA 19104
United States

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