Behavioral Biases of Mutual Fund Investor

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Behavioral Biases of Mutual Fund Investor

Main Points of the Paper

Warren Bailey, Alok Kumar, and Ng look at the effects of the biasness that investors display on the choices of mutual funds of a big sample of American discount brokerage utilizing newly incorporated components encompassing demographic and behavioral features of early researches, level of awareness on tax, familiarity of biasness regarding fund-level, and state of the news. The scholars realize upon completing their investigation that in many scenarios, investors who are behaviorally biased tend to take poor decisions regarding their frequency of trade, style of funding, the expenses, and the time, causing unexpected outcome. The study further discovers that emergence of different trends happens to be connected to behavioral biasness, and not from the managerial competence displayed in the past undertakings. The study by Bailey, Kumar, and Ng (1) holds that investors who are biased normally fall into stereotypes that can be grouped into the groups of a mature, narrow framer, overconfident, smart, and a gambler.

The researchers embark on the study after learning of the fact that studies in the past touching on the biasness related to investment only focus on individual stocks, and learning that individual investors usually depict some level of biasness when picking stocks. The investigators are primarily motivated by the fact that not much has been carried out to comprehend the connection between the biases individual investors have to their investment of funds mutually. The surveyors also get the desire to conduct the study after it becomes apparent that more individual investors are turning towards mutual funds to put their investment in the equity markets rather than trading in individual stocks. The data Bailey, Kumar, and Ng (1) give indicate that whereas individuals held nearly 47.8% of the market in the beginning of 1980, the number declined to 21.5% in the beginning of 2007. The drop is related to an upsurge in the state of mutual funds, from about 4.6% in the 1980s, to about 32% in 2007, thus making it quite essential to comprehend how individuals invest and trade in mutual funds (Bailey, Kumar and Ng 1).

The scholars embrace two aspects to study and understand the connections and effects of the choice of mutual funds and the biasness individuals tend to display. First, they carry out tests among individual investors, and estimations of several measures of behavioral biasness for every person in the sample are applied to narrate choices of individual investor across individual stocks, other forms of mutual funds, and index funds (Bailey, Kumar and Ng 2). The researchers also carry out tests to find out whether the biasness individuals display impact on the connections between the recent past performance in fund and trading choices because the biases could lead some investors to use information on performance inappropriately. The three scholars also carry out tests across dissimilar forms of funds, and summarize the period of investor holding by individuals as well as returns in mutual funding defined by the magnitude of behavioral biasness of every fund investor and the structure of fee (Bailey, Kumar and Ng 3). Bailey, Kumar, and Ng also evaluate a number of past documents to acquire much insight on the specific measures or tenets of the mutual fund decisions individual investors make.  

The findings of Bailey, Kumar, and Ng are as follows. The investigators discover that investors who have relatively higher income, are more informed, are older, and have more experience make appropriate use of mutual funds, tend to hold a higher quantity of funds for longer periods, try to avoid high expenses, and in many situations achieve satisfying outcome (Bailey, Kumar and Ng 3). Investors who have strong biasness as part of their behavior, or who do not pay adequate attention to macro-economic content or who have high behavioral biasness are not highly likely to settle on mutual funds or settle on such an approach for no apparent reasons. The study discovers that when such traders acquire mutual funds, they frequently trade them, prefer active and higher expense funds to index funds, and happen to be timely with their purchases as well as sell so badly (Bailey, Kumar and Ng 3). The inquiry further revealed that biased investors tend to chase the performance of funds, thereby casting doubt as to whether the act of chasing trend really depicts a rational choice in selecting funds.

Behavioral Theories in the Paper

Reading the paper one gets to learn behavioral theories that influences the actions of individual investors and one of these influential theoretical concepts is the disposition effect, which is significant in influencing behavioral biases impacting on the selection of mutual fund. The disposition effects works in such a manner that investors tend to overestimate the anticipated period of holding, and to mistakenly choose higher front-end funds (Bailey, Kumar and Ng 2). Such an approach contrasts investors who have narrower framing biasness because such persons purchase without looking at the total effects of portfolio, and who tend to be much confident.

Critics and Weaknesses of the Paper

The paper presents vital insight on the possible factors that drive investors to prefer mutual funding as opposed to the individual investment that was trending in the past, which might be very essential to learners and other researchers as well. The writers try very much to be elaborate in their presentation, and this is the reason they choose a detailed narration approach. The paper is also effective in the way it employs statistical data to offer precise measures rather than sticking to theoretical approaches that may not be as informative as employing statistical evaluation (Bailey, Kumar and Ng 6). Other than the use of statistical data to make the study more real and convincing, the authors present their data using tables to help readers acquire the concept without much struggle or without having to spend a lot of time going through the whole document trying to locate specific points. Instead, the table presents vital components that help to acquire so much information within short period. The investigators also display proficiency in the paper by using numerous references to allow readers confirm what they read, and to present more opportunity to carry out further inquiry into the matter. Otherwise, the information in the article would not be as convincing if the authors did not reference their work. The authors also present the list sources they use thereby making it easy for readers to carry out further inquiry into the issue.

Even though the paper depicts some strong features, it is vital to understand some of the weaknesses that are evident in the scholarly work. One of the weaknesses is the paper is developed in such a manner that it might be difficult for undergraduates or individuals without adequate knowledge or prior insight to understand what the authors are trying to communicate. Other than using technical terms that may only suite graduate learners or researchers who look into a particular factor, the graphical presentations (tables) present statistical data that would require adequate knowledge to comprehend what the investigators present. Taking the example of table 8, which shows the behavioral biasness, the features of mutual fund portfolio, and the performance of portfolio, for example, employs a cross-section regression approach as well as the Sharpe ratio computational approach to analyze data, thus making the content not very easy for learners who are not at their advanced levels to understand with ease (Bailey, Kumar and Ng 19). The same applies to table 9, which shows the connection between the aggregated behavior biasness and other features, fund choices, and repercussions (Bailey, Kumar and Ng 21). Looking at the table, one might not deduce its meaning or exact requirements unless after going through a significant portion of the document and gets some assistance on how to interpret the data. Indeed, such level of complexity in the way the authors present the statistical data indicate the paper’s one form of weakness, which may keep some readers away from knowing what the authors present.

The other weakness is the study and its outcome is only bound within American individual investors, thus creating some form of uneasiness as to whether the outcome is a reflection the scenario across the globe. Bailey, Kumar and Ng make it clear that they only pay attention to individual investors in the U.S., and how behavioral biasness tend to impact on the individual decisions to have individual stocks rather than investing in mutual funds (Bailey, Kumar and Ng 24). The study, however, would be more enlightening if the investigators compared with other nations to affirm whether it is true that investors who have relatively higher income, levels of education, and experience in investment practices are likely to utilize mutual funds and get more benefits from taking such decisions. The inquiry would also be more enlightening if it compared with other nations to show whether persons with behavioral biasness that is so strong happen to embrace individual stocks and keep away from expense index funds that are low. Carrying out inquiries from other regions and affirming that investors with strong biases happen to trade more often, do not plan or time their purchases and sells well, invest in mutual funds, and do not prefer index funds (Isidore and Christie 73) would affirm that the argument in the paper in valid, and not only applicable in the U.S. Other than the weaknesses mentioned herein, the document is educative, and is enlightening to investors who may either want to put their investment in individual stocks or mutual funds.

Suggestions and Future Ideas

Investigators should not relent in their studies to acquire much insight on how such ways of investment could change or remain the same in the coming years. Investigators if possible should rely on past information to understand how the change is taking place, and should be willing to share information such that the findings are harmonized and not clashing so evidently. Coming up with harmonized findings will restore confidence among learners and any other group in need of such information, and would help investors understand the merits and demerits associated with both individual or investment in mutual funds (Jasmine and Basariya 46). Furthermore, future investigations should create a clear distinction on the merits and demerits of utilizing either way of investment to avoid the poor decision-making usually associated with investment of funds, either in individual stocks or mutual funds (Jasmine and Basariya 46). Other than clarifying the merits and demerits associated with each approach, the findings would be more convincing to the audience when scholars come together to carry out investigations over a wider scale and find out whether the outcome still holds. Repeated findings would suggest that the discovered outcome is valid, and no amount of alterations or inquiries would change the state of things.

Such reports would also be more enlightening when investigators spend considerable time presenting more features, rather than focusing on limited aspects as it appears with Bailey, Kumar and Ng who mostly pay attention on the biases pushing individuals to mutual funds. Investigators in the coming years, for instance, may choose to focus on the objectives that drive people to choose a particular investment plan as opposed to the other, and may also describe how investors could monitor the performance of their investment, to know whether they are headed towards the right direction. More importantly, future studies would be more educative and impactful if investigators offer insight on factors that exit load, which Trivedi, Swalin and Dash (215)describe as the cost investors are likely to incur when withdrawing some portion of their investment. Scholars in the field should not relent in their investigations to deliver outcomes and directives that are more effective and influential.

Works Cited

Bailey, Warren, Kumar Alok and Ng David. “Behavioral Biases of Mutual Fund Investors.”

            Journal of Financial Economics, vol. 102, 2011, pp. 1-27.

Isidore, Renu and Christie Patrick. “Review of the Individual Equity Investor’s Behavior in the

            Indian Context.” Ge-International Journal of Management Research, vol. 3, no. 6, 2015,

            pp. 71-75.

Jasmine, Katherine and Basariya Rabiyathul. “A Study on the Customers Benefits on Mutual

            Funds.” International Journal of Civil Engineering and Technology, vol. 9, no. 4, 2018,

            pp. 45-48.

Trivedi, Rajesh, Swalin Prafulla, and Dash Manoranjan. “A Study of Investor’s Perception

            Towards Mutual Fund Decision: An Indian Perspective.” International Journal of

            Economic Research, vol. 14, no. 9, 2017, pp. 209-219.