Saturday, March 15, 2008
Mutual Fund Investors: Divergent Profiles, by ALAN R. PALMITER, Wake Forest University - School of Law, and AHMED E. TAHA, Wake Forest University - School of Law, was recently posted on SSRN. Here is the abstract:
Mutual funds are owned by almost half of all U.S. households, manage over $12 trillion dollars in assets, and have become a primary vehicle for investment and retirement savings. Who are mutual fund investors? The answer is critical to regulatory policy. Fund investors, by selecting the funds in which they invest, play a central role in determining asset allocation and in controlling the fees funds charge. Thus, the functioning of the mutual fund market turns on the knowledge and financial sophistication of fund investors.
This article examines the profiles of mutual fund investors presented by the mutual fund industry, by the SEC, and by an extensive empirical academic literature produced primarily by finance professors. The industry portrays fund investors as diligent, fairly sophisticated, and guided by professional financial advisers. The industry claims that the result is a competitive mutual fund market as fund investors demand low costs and solid performance. The SEC's regulatory policy paints a more cautious portrait of fund investors. While acknowledging that many investors have limitations, the SEC touts improved disclosure by the industry as a sufficient antidote. The academic literature, however, finds that fund investors are generally ignorant and financially unsophisticated. Most investors are unaware of even the basics of their funds, do not take costs (especially ongoing costs) into account when they invest, and chase past fund performance, despite little evidence that past returns predict future returns. Fund investors who use financial advisers do no better.
The SEC's belief that fund investors can fend for themselves, once armed with adequate disclosure, fails to appreciate the extent of investors' limitations. Instead, the findings of the academic literature suggest that policymakers should rethink the current regulatory approach. Disclosure may not be enough.