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Article Excerpt
Choosing how to best invest for retirement is one of the most important decisions a consumer can make. Unfortunately, this can be an especially challenging task given the current financial information disclosure environment. The objective of this research was to explore whether a modified method of supplemental information disclosure impacts investors' fund evaluations and investment intentions. Results indicate that while investors continue to place too much emphasis on prior performance, the provision of supplemental information, particularly in a graphical format, interacts with performance and investment knowledge to influence perceptions and evaluations of mutual funds.
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Making wise financial investments is one of the most important and challenging decisions faced by consumers. One way to maintain and build wealth is to purchase shares in one or more of the thousands of available mutual funds. Millions of individuals count on these funds to provide them with a comfortable retirement income (Investment Company Institute 2005). This issue becomes increasingly important with the push by both government and industry to privatize individual retirement accounts. Corporations are shifting the pension burden from a defined pension benefit program to 401(k) programs managed primarily by employees. The 401 (k) plans offered by employers are now the primary form of retirement savings for over forty-two million Americans with nearly two trillion dollars in assets (Lauricella 2004). Proponents of privatization argue that individuals should, from a normative perspective, have the fight to manage their own money. Proponents also argue that individuals could realize greater returns by investing a portion of their Social Security savings into the stock market. For example, a Bush administration proposal would allow individuals to choose from a range of investment options once their Social Security account reached a specified minimum amount. Opponents of privatization argue that novice investors unfamiliar with risk and diversification leave themselves vulnerable to fluctuations within the market. These fluctuations, critics argue, could result in a substantial decline in retirement earnings of those individuals who need the money the most. Employers are increasingly concerned with the difficulty of getting employees familiar with the basics of 401(k) plans. Education has become more difficult with the number of investment options increasing for eligible employees of many company retirement plans. Data support this conclusion. To illustrate, for the ten years ended in 2002, the median return on company-managed investment accounts averaged 6.81% versus 6.35% for employee-managed investment accounts. This difference could result in a difference of $88,000 over a thirty-year period for a $100,000 investment (Lauricella 2004).
Innovations in financial services and information technology, as well as increased financial disclosure requirements mandated by regulators, have created a choice environment replete with information. However, navigating through the plethora of information is not an easy task. Investors face mutual fund prospectuses crammed with data regarding a fund's return performance, management expenses, loads, and marketing fees, as well as details of the portfolio's holdings. Given the sheer quantity of available information to investors and the thousands of funds from which to choose, picking the fund that most appropriately matches his/her personal risk-return trade-off is a challenging task even for the savviest of investors.
The provision of information in a choice situation typically can provide important consumer benefits such as improved decision making, enhanced product quality, and lower prices (Mazis et al. 1981). However, in order for that information to have a positive impact on the consumer decision-making process, it must be easily accessible and presented in a clear and understandable format. Unfortunately, the wide variety of choices and information, coupled with an awareness of the need to make wise investment decisions, has made investing in a mutual fund a stressful and confusing decision-making process. Scholars have issued a call for more consumer research that specifically explores ways to facilitate the most important and challenging decisions made by consumers (Bazerman 2001). Investigating investors' financial knowledge and perceptions of investment products is a clear example of such research.
Within the policy domain, there have been specific calls for format testing of summary disclosures of financial information (Woodward 2004a). Both the Federal Trade Commission and the Securities and Exchange Commission (SEC) have investigated the possibility of mandating a standardized summary disclosure in order to improve consumer comprehension, facilitate fund differentiation, and increase awareness of key information (Woodward 2004a, 2004b). For example, the SEC is aware that the ordinary investor faces a complex decision when choosing a mutual fund, and thus, the SEC provides a detailed online guide that describes numerous relevant factors related to risk, return, and expenses (e.g., SEC 2006). In addition, SEC Chairman Christopher Cox has proposed using Web-based "tagging" technology to make it easier for investors to compare the performance of different mutual funds. Research by the Investment Company Institute, an organization that represents the mutual fund industry, supports the revamping of the disclosure mechanism to include interactive data (West 2006). Tagging involves the placement of electronic tags on specific data items (e.g., revenue, profit margins, or reserves), which allows investors to compare these interactive data across companies and industry groups. However, it is not clear whether the use of such technology, if implemented in its currently proposed format, will result in a standardized summary disclosure of the most-salient mutual fund data.
Critics of financial service firms argue that they keep the cost of investing low while charging customers exorbitant fees (Bazerman 2001; Zweig 2000). In a study of the S&P 500 index fund market, researchers found that while average fees rose, the market share of the most economical funds fell (Hortacsu and Syverson 2003). According to the authors, the lowest-cost S&P 500 index fund has expenses of approximately 9.5 basis points, while the highest-cost fund has fees of 268 basis points (Hortacsu and Syverson 2003; Woodward 2004b). Individuals investing in the lower-expense fund would have double the retirement income versus the more expensive fund (Woodward 2004b). Investors, critics argue, lack the knowledge to differentiate between high- and low-cost investment products (Bazerman 2001; Yohannes 1988). Thus, the purpose of this research is to explore the effects of salient summary information about a mutual fund on investor perceptions and fund evaluations. Clearly, this issue has important public policy implications. The inability of investors to make wise investment decisions may have a significant negative impact on their quality of life in retirement and increase the likelihood of their dependence on government assistance programs.
BACKGROUND AND LITERATURE REVIEW
The percentage of novice investors who own mutual funds has grown more than eightfold over the past twenty-five years (2005 Investment Company Institute Fact Book). Over that period, innovations in financial services and information technology, as well as increased financial disclosure requirements mandated by regulators, have led to an explosion of information that is disseminated to the novice investor. The rapid growth in assets under management over the period of 1980-2004 and the increased exposure of U.S. household wealth to the stock and bond markets have provided the novice investor with a wider array of choices in terms of types of funds, investing styles, risk, and expense information. Mutual fund prospectuses now brim with data on a fund's return performance, management expenses, loads, and marketing fees, as well as details of the portfolio's holdings.
The increase in fund choice and fund information, coupled with the general public's greater awareness of the need to invest wisely in order to meet personal financial goals, has increased the average investor's desire to make effective decisions related to the choice of mutual funds that meet his/her return objectives while taking on an acceptable level of risk. Unfortunately, research in finance, economics, and the psychology of economic decision making suggests that the average investor has difficulty dealing with the complexity of sifting through mutual fund data in order to make investment decisions that properly balance risk, return, as well as the management expenses and operating costs of a fund. For example, Benartzi and Thaler (2001) find that mutual fund choices for the defined contribution pension plans of employees at a large university and a commercial airline company were determined largely by the number of stock and bond fund choices presented within each plan. That is, a plan that had more bond funds than stock funds led to a disproportionately high share of retirement savings being allocated to the more-conservative bond funds. Conversely, a plan that offered more stock funds than bond funds led investors to allocate a disproportionately large share of savings to stock funds. The authors conclude that their findings are consistent with a naive "1/n" allocation strategy where a roughly equal share of savings is allocated across...
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