Investor Behavior: The Psychology of Financial Planning and Investing

CHAPTER 29

Mutual Funds and Individual Investors: Advertising and Behavioral Issues

John A. Haslem

Professor Emeritus of Finance, Robert H. Smith School of Business, University of Maryland

INTRODUCTION

The purpose of this chapter is to review interactions between mutual funds and individual investors in choosing equity mutual funds. Probably the largest question is why both sophisticated and unsophisticated investors persist in investing in actively managed funds that generally result in underperformance. Actively managed funds have a long history of spending money on advertising because they find that it results in increasing assets under management. Fund management companies realize that investors chase past performance in the mistaken belief that historical returns predict future investment performance. Funds further take advantage of investors by increasing advertising when past performance is high. Advertising encourages many investors to make fund choices because they are inexperienced, unaware, and have low financial literacy, including a lack of knowledge of both transparent and obscure fund commissions, expenses, and charges. Any persistence in high fund performance is also much more likely attributable to luck than to portfolio manager's expertise. The Securities and Exchange Commission (SEC) has also failed to prohibit performance advertising or to require it to be understandable.

The remaining sections provide a discussion of the following topics: (1) advertising and ...