October 23, 2005
Are Investors Rational??
While doing some research for a recent investment, I ran a Google search on rational investing in S&P 500 funds. I was looking for some information on whether it would be more rational to invest in an ETF or a standard S&P 500 tracking mutual fund. I never did find anything which answered my question for my personal situation, but I did run across a very interesting article by Edwin J. Elton, Martin J. Gruber, and Jeffrey A. Busse. The article is entitled Are Investors Rational? Choices Among Index Funds, and a copy can be found here in MSWord format.
First, I must note that the article has used a few formulas and statistical regressions, so it might not be an easy read. However, the authors do an excellent job describing their results.
Next, I found some startling facts regarding the performance of S&P 500 mutual funds. For example, among the 52 open-end S&P 500 index funds used in the survey, from January 1996 to December 2001, the difference in annual return between the best performing and worst performing S&P index fund was 2.09 percent per year.
Additionally, the authors do show that cash flows and performance are statistically significant, but they find that it is much weaker than they expected, based on rational behavior.
Finally, the authors find that, even though they expect mutual fund investors to be "rational" and allocate their money to maximize their economic payoff, the article shows that this was not the case.
I found it an extremely good read and strongly recommend it.
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