Why Does the Law of One Price Fail? An Experiment on Index Mutual Funds
Experimental subjects review four S&P 500 index fund prospectuses and then allocate $10,000 across those funds. We randomly select subjects to be paid for their subsequent portfolio performance. Subjects cannot access any non-portfolio services such as financial advice from their selected funds. Nevertheless, they overwhelmingly fail to minimize their index fund fees. When we make fund fees salient and transparent, subjects' portfolios shift towards lower-fee index funds, but over 80% still do not invest all of their money in the lowest-fee fund. When funds' annualized returns since inception are made salient, portfolios shift towards index funds with higher returns since inception, even though variation in these returns is irrelevant for forecasting future returns. We present evidence that investors in high-cost index funds sense that they may be making a mistake.
We are indebted to David Borden, Carlos Caro, Ananya Chakravarti, Keith Ericson, Shih En Lu, Dina Mishra, and Kelly Shue for their excellent research assistance. We thank Gideon Saar and seminar participants at the NBER , University of Connecticut, University of Maryland, University of Pennsylvania, and Yale University for helpful comments. Choi, Laibson, and Madrian acknowledge individual and collective financial support from the National Institute on Aging (grants R01-AG021650 and T32-AG00186) and the U.S. Social Security Administration through grant #10-P-98363-2 to the National Bureau of Economic Research as part of the SSA Retirement Research Consortium. The findings and conclusions expressed are solely those of the authors and do not represent the views of NI A, SSA, any other agency of the Federal Government, or the NBER. Choi acknowledges financial support from the Mustard Seed Foundation. Laibson acknowledges financial support from the Sloan Foundation.