The Tradeoff Between Mutual Fund and Direct Stock Investments – A Theoretical Analysis Involving Different Types of Investors

Posted: 23 Mar 2016

See all articles by Marcel Fischer

Marcel Fischer

Copenhagen Business School

Bertram I. Steininger

Royal Institute of Technology (KTH); ZEW – Leibniz Centre for European Economic Research - International Finance and Financial Management

Date Written: March 13, 2013

Abstract

We study the tradeoff between direct and indirect stock investments through equity mutual funds for a utility-maximizing investor. Whereas direct investments impose higher transaction costs on the formation of a well-diversified portfolio, mutual funds charge fees for their services. Our results show that the fee levels that make private investors indifferent between direct and indirect stock investments vary heavily according to risk aversion, the amounts invested, correlations between assets, transaction costs, and the length of investment horizon. In particular, our results suggest that for a wide range of actively managed mutual funds, the fees charged are too high for these mutual funds to appeal to a wide range of informed investors. However, accounting for search costs, such as costs for financial advice, can facilitate an understanding of the levels of management fees charged by mutual funds existing in the market.

Keywords: Portfolio choice, Mutual funds Management fees, Transaction costs, Diversification

JEL Classification: G11, D14, G25

Suggested Citation

Fischer, Marcel and Steininger, Bertram I., The Tradeoff Between Mutual Fund and Direct Stock Investments – A Theoretical Analysis Involving Different Types of Investors (March 13, 2013). Available at SSRN: https://ssrn.com/abstract=2753347

Marcel Fischer

Copenhagen Business School ( email )

Solbjerg Plads 3
Frederiksberg C, DK - 2000
Denmark
+45-3815-3628 (Phone)

Bertram I. Steininger (Contact Author)

Royal Institute of Technology (KTH) ( email )

Stockholm
Sweden

ZEW – Leibniz Centre for European Economic Research - International Finance and Financial Management ( email )

Postfach 103443
Mannheim, D-68034
Germany

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