Fooled by Success: How, Why, and When Disclosures Fail or Work in Mutual Fund Ads

Abstract

Mutual fund advertisers often highlight their funds’ past returns, albeit with a disclosure mandated by the Securities and Exchange Commission (SEC). To ascertain whether the SEC disclosure is effective and how it could be improved, the authors conduct seven experiments regarding individuals’ choice of mutual funds with ads touting past success plus disclosures. These experiments lead to several findings: First, current SEC disclosures do not work because investors fall prey to the “hot hand” bias and believe that past performance trends will continue. Second, although investors comprehend the content of the SEC disclosure, they misapply it. Third, an alternate stronger, less ambiguous disclosure effectively attenuates investors’ preferences for funds with longer (vs. shorter) performance runs. Fourth, only a disclosure that directly relates to the beliefs that give rise to the hot hand bias overcomes peoples’ tendency to chase returns. Fifth, these findings generalize to the real estate context. This is the only research that shows that when the SEC disclosure found in mutual fund ads is pitted against the hot hand bias, the hot hand wins out. However, a strongly worded disclosure has some success at debiasing individuals. The authors also discuss implications for policy makers, practitioners, and consumers.