Research Thursday: What single sentence of investment advice can make us better investors?
Which of these three sentences do you think would help investors make better decisions...
1) Past performance does not guarantee future performance
2) Some people invest based on past performance, but funds with low fees have the highest future results
3) The most important single factor in mutual fund performance is the fund’s fees
Answer: #2 Some people invest based on past performance, but funds with low fees have the highest future results
Why did #2 work best?
First some background on the research from Behavioral Scientist:
Real-world financial decisions are incredibly complex. Researchers often try to isolate variables by getting experimental participants to make hypothetical investment decisions (but with real financial consequences). In our research, conducted in the U.S., we asked participants to choose between four stock mutual funds. Following previous research, we arranged funds so that the fund that had historically performed best also had the highest fees. Although in reality this fund would be a statistical anomaly (stock funds with the lowest fees have the highest average returns), it allowed us to separate the strategies of maximizing past performance and minimizing fees. A one-sentence piece of investment advice was placed immediately above where participants clicked their final choice.
Good tip buried in there: You are better off focusing on fees vs. historical performance since that is a better predictor of investor returns.
So why was this sentence more effective? Think social comparison...you don't want to be like everyone else who invests based on a flawed metric (past performance).
We found that advice based on social comparison, “Some people invest based on past performance, but funds with low fees have the highest future results,” performed far better across three experiments than a piece of factually-equivalent but non-social advice, “Past performance does not guarantee future performance.” We also found that the social comparison advice worked better even than the following disclaimer, which previous research suggested as an improvement on the current real-world advice: “The most important single factor in mutual fund performance is the fund’s fees.” Small changes in how investment advice is worded can substantially improve behavior—another demonstration of the power of nudge.
About the Author
Tim's saving habits started at seven when a neighbor with a broken hip gave him a dog walking job. Her recovery, which took almost a year, resulted in Tim getting to know the bank tellers quite well (and accumulating a savings account balance of over $300!). His recent entrepreneurial adventures have included driving a shredding truck, analyzing executive compensation packages for Fortune 500 companies and helping families make better college financing decisions. After volunteering in 2010 to create and teach a personal finance program at Eastside College Prep in East Palo Alto, Tim saw firsthand the impact of an engaging and activity-based curriculum, which inspired him to start a new non-profit, Next Gen Personal Finance.
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