Financial Literacy and Mutual Fund Investments : Who Buys Actively Managed Funds?

Müller, Sebastian ; Weber, Martin

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URN: urn:nbn:de:bsz:180-madoc-22786
Document Type: Working paper
Year of publication: 2008
The title of a journal, publication series: None
Publication language: English
Institution: Business School > Sonstige - Fakultät für Betriebswirtschaftslehre
MADOC publication series: Lehrstuhl für ABWL, Finanzwirtschaft, insb. Bankbetriebslehre (Weber) > Working Papers
Subject: 330 Economics
Classification: JEL: G11 ,
Subject headings (SWD): Kapitalanlage , Wissen , Investmentfonds , Anlageverhalten , Kapitalanleger
Keywords (English): financial literacy , investor sophistication , mutual funds , mutual fund customers , better-than-average , miscalibration
Abstract: Previous research indicates that lacking financial sophistication among private investors might be important in explaining the strong growth in active management over the past. Based on questionnaire data with more than 3,000 mutual fund customers, we therefore construct an objective financial literacy score and analyze the relationship between financial literacy and mutual fund investment behavior. While sophisticated investors are indeed more aware of passive, low cost fund alternatives like index funds or Exchange Traded Funds (ETF), financial literacy has only a modest impact on the decision to invest passively rather than actively. "Smart money" among smarter investors cannot explain this finding: There is only very weak evidence of superior fund selection abilities among more financially literate investors at best. In contrast, our results suggest that overconfidence is an important determinant of the decision to invest active vs. passive. Smarter investors believe to be better than average in their fund choices, but our results show that they are not. In additional analyzes we show that although more sophisticated participants pay lower front-end loads and have more accurate performance perceptions, no relationship exists between financial literacy and ongoing fund expenses. Our results indicate that the lack of financial literacy among most mutual fund customers cannot completely explain the growth in actively managed funds over the past.
Additional information: Available at SSRN:

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