NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Does Simplified Disclosure Affect Individuals' Mutual Fund Choices?


…the Summary Prospectus reduces the amount of time spent on the investment decision, but there does not seem to be any resulting change in the portfolio choices of individual investors.

Because some regulators believe that the average investor has a hard time reading the statutory prospectuses that mutual funds distribute, the SEC recently proposed and subsequently adopted a new simplified disclosure document. Mutual funds now have the option of sending investors this two-to-four-page document, dubbed the “Summary Prospectus,” instead of the statutory prospectus. The Summary Prospectus contains key information about the mutual fund’s investment objectives, strategies, risks, costs, and performance.

In How Does Simplified Disclosure Affect Individuals' Mutual Fund Choices? (NBER Working Paper No. 14859), authors John Beshears, James Choi, David Laibson, and Brigitte Madrian find that the Summary Prospectus reduces the amount of time spent on the investment decision, but there does not seem to be any resulting change in the portfolio choices of individual investors.

The authors’ research also highlights the scope of investor confusion regarding sales loads. In an experimental setting, investors were presented with several different mutual fund choices with different loads. Even when participants had a one-month investment horizon, so it was very unlikely that a fund’s expected return over this period would offset the load, they did not appear to avoid loads. Subjects in the experiment chose funds with an average load that was 200 basis points higher than the minimum cost portfolio, despite their short investment horizon; this choice could only make sense if investors’ expected returns on the load funds were 27.4 percentage points higher than the returns on the no-load funds. The authors conclude that subjects either don’t understand how loads work or don’t take them into account in making investment decisions. It does not appear that the Summary Prospectus has increased investor understanding of these issues.

For this analysis, the authors recruited 186 non-faculty white-collar staff members at Harvard University to participate in a portfolio allocation experiment. All of the subjects allocated two portfolios: one among four actively managed equity mutual funds, and one among four actively managed bond mutual funds. Subjects’ payments depended on how their chosen portfolios actually performed subsequent to the experimental session, and averaged approximately $100 per subject.

The subjects were randomized into one of three information conditions: in the first, subjects received only the funds’ statutory prospectuses; in the second, subjects received only the funds’ Summary Prospectuses, which the authors constructed using the original SEC proposal’s specifications; in the third, subjects received the Summary Prospectuses but could also request the statutory prospectuses (a request that only a few of the subjects actually made). Subjects were assigned to be paid randomly based on either their subsequent one-month portfolio return or their subsequent one-year portfolio return.

-- Lester Picker


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