Financial Literacy and Mutual Fund Investments: Who Buys Actively Managed Funds?

Abstract

Previous research indicates that a lack of financial sophistication might explain the past strong growth in active management. We construct an objective financial literacy score and analyze the relation between financial literacy and mutual fund investment behavior. We show that there is a positive influence of financial literacy on the likelihood of investing in low-cost fund alternatives. However, we find that even the most sophisticated investors in our sample rely overwhelmingly on active funds. “Smart money” among smarter investors cannot explain this finding as there is only weak evidence of superior fund selection abilities among financially more literate investors. Our results indicate that the lack of financial literacy among most mutual fund customers cannot completely explain the past growth in actively managed funds.

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Correspondence to Martin Weber.

Additional information

We would like to thank two anonymous referees and seminar participants at the University of Mannheim for valuable comments and insights. We thank Sebastian Dyck for his assistance in programming the questionnaire. Financial support from the Deutsche Forschungsgemeinschaft, SFB 504, at the University of Mannheim, is gratefully acknowledged

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Müller, S., Weber, M. Financial Literacy and Mutual Fund Investments: Who Buys Actively Managed Funds?. Schmalenbach Bus Rev 62, 126–153 (2010). https://doi.org/10.1007/BF03396802

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JEL-Classification

  • G11

Keywords

  • Better-than-Average
  • Financial Literacy
  • Investor Sophistication
  • Miscalibration
  • Mutual Fund Customers
  • Mutual Funds