The Mutual Fund Investor

Abstract

This chapter for an upcoming handbook on mutual funds (by Edward Elgar Publishing) offers an overview of the mutual fund market and the investors who inhabit it. On the supply side, mutual funds hold $16 trillion in financial assets and have become the largest component of our private retirement system. On the demand side, mutual fund ownership has become widespread, with 90 million fund-owning households composed mostly of middle-class, educated, and older investors.The portrait of mutual fund investors, painted by a large and consistent body of academic and government studies over the past few decades, is disturbing. Fund investors are mostly ignorant of fund characteristics, inattentive to risks (and opportunities) of different asset classes, and often insensitive to fund fees. Instead, fund investors tend to chase past returns and attempt to time the market. As a result, the average returns for fund investors (both in stock and bond funds) have significantly trailed benchmark market returns – according to some studies, by several percentage points.The role of financial intermediaries in the mutual fund market is also disconcerting. Often, financial advisers give fund investors conflicted advice, leading them to choose high-cost, under-performing funds on which the advisers garner commissions. Although some employers are shifting employees to low-cost, risk-appropriate balanced funds, many 401(k) plans remain less than optimal. Moreover, fund companies tout higher-cost actively managed funds, despite growing evidence that most, if not all, fund managers are unable to beat the market – particularly after fees.There are, however, glimmers of hope. Recently, many fund investors have moved to lower-cost index funds – reflecting a new sensitivity both to the importance of low costs and to the empty promise of active fund management. Target date funds have also established a beachhead in the 401(k) market. The recent clarion calls of the financial press reinforces these trends, as a growing drumbeat of stories emphasizes the importance of fund fees, the counter-productivity of trying to beat or time the market, and the emptiness of chasing past fund performance.