Nudging investors big and small toward better decisions

Abstract

Investors significantly reduce their future returns by selecting mutual funds with higher fees, allured by higher past returns that do not predict future performance. This suboptimal behavior, which can roughly halve an investor’s retirement savings, is driven by 2 psychological factors. One factor is difficulty comprehending rate information, which is critical given that mutual fund fees and returns are typically communicated in percentages. A second factor is devaluing small differences in returns or fees (i.e., a peanuts effect). These 2 factors interact such that large investors benefit when fees are stated in currency (as opposed to percentages), whereas small investors benefit from returns stated in currency. These striking results suggest behavioral interventions that are tailored specifically for small and large investors.