Why Do Retail Investors Make Costly Mistakes? An Experiment on Mutual Fund Choice

Congress has recently acknowledged the need for a better understanding of investor behavior. In the Dodd–Frank Act, Congress instructed the SEC to conduct a study of investor financial literacy. The SEC’s study was conducted at the most superficial level, however, and provided limited insight into developing future regulatory policy. Although the SEC found investor mistakes and misconceptions, it did not seek to identify the reasons for these mistakes or to understand the underlying mechanisms driving investor choices.

This Article takes up where the SEC study left off. We report the results of an experiment designed to explore how investors use the information provided to them, and why they often ignore it. Using a simulated investment game in which participants were asked to allocate funds in a retirement account among ten mutual fund alternatives, we offer some insights into how individuals seek and assimilate information about a fund’s characteristics. In particular, our experiment offers a novel addition to the body of experimental evidence on investor decisionmaking by incorporating a technology that allows us to collect data on the specific information that investors choose to view.

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