Cognitive Dissonance and Mutual Fund Investors

Author: William N. Goetzmann and Nadav Peles

We present evidence from questionnaire studies of mutual fund investors about recollections of past fund performance. We find that investor memories exhibit a positive bias, consistent with current psychological models. We find that the degree of bias is conditional upon previous investor choice, a phenomenon related to the well known theory of cognitive dissonance.

The magnitude of psychological and economic frictions in the mutual fund industry is examined via a cross-sectional study of equity mutual funds. We find an unusually high frequency of poorly performing funds, consistent with investor "inertia." Analysis of aggregate dollar investments however, shows the net effect of this inertia is small. Thus the regulatory implications with respect to additional disclosure requirements are limited.

We examine one widely documented empirical implication of mutual fund investor inertia: the differential response of investment dollars to past performance. We perform tests that control for the crucial problem of survivorship. These confirm the presence of differential response, but find the effect is confined to the top quartile. There is little evidence that the response to poor performance is unusual.

Goetzmann, W. N. & Peles, N. 1995, 'Cognitive Dissonance and Mutual Fund Investors'

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