The Tradeoff Between Mutual Fund and Direct Stock Investments: A Theoretical Analysis Involving Different Types of Investors

Marcel Marekwica, Bertram I. Steininger

Research output: Contribution to journalJournal articleResearchpeer-review

Abstract

We study the tradeoff between direct and indirect stock investments
through equity mutual funds for a utility-maximizing investor. Whereas direct
investments impose higher transaction costs on the formation of a well-diversified portfolio, mutual funds charge fees for their services. Our results show that the fee levels that make private investors indifferent between direct and indirect stock investments vary heavily according to risk aversion, the amounts invested, correlations between assets, transaction costs, and the length of investment horizon. In particular, our results suggest that for a wide range of actively managed mutual funds, the fees charged are too high for these mutual funds to appeal to a wide range of informed investors. However, accounting for search costs, such as costs for financial advice, can facilitate an understanding of the levels of management fees charged by mutual funds existing in the market.
Original languageEnglish
JournalReview of Managerial Science
Volume8
Issue number2
Pages (from-to)197–224
ISSN1863-6683
DOIs
Publication statusPublished - 2014

Cite this

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title = "The Tradeoff Between Mutual Fund and Direct Stock Investments: A Theoretical Analysis Involving Different Types of Investors",
abstract = "We study the tradeoff between direct and indirect stock investmentsthrough equity mutual funds for a utility-maximizing investor. Whereas directinvestments impose higher transaction costs on the formation of a well-diversified portfolio, mutual funds charge fees for their services. Our results show that the fee levels that make private investors indifferent between direct and indirect stock investments vary heavily according to risk aversion, the amounts invested, correlations between assets, transaction costs, and the length of investment horizon. In particular, our results suggest that for a wide range of actively managed mutual funds, the fees charged are too high for these mutual funds to appeal to a wide range of informed investors. However, accounting for search costs, such as costs for financial advice, can facilitate an understanding of the levels of management fees charged by mutual funds existing in the market.",
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The Tradeoff Between Mutual Fund and Direct Stock Investments : A Theoretical Analysis Involving Different Types of Investors. / Marekwica, Marcel; Steininger, Bertram I. .

In: Review of Managerial Science, Vol. 8, No. 2, 2014, p. 197–224.

Research output: Contribution to journalJournal articleResearchpeer-review

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AU - Marekwica, Marcel

AU - Steininger, Bertram I.

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N2 - We study the tradeoff between direct and indirect stock investmentsthrough equity mutual funds for a utility-maximizing investor. Whereas directinvestments impose higher transaction costs on the formation of a well-diversified portfolio, mutual funds charge fees for their services. Our results show that the fee levels that make private investors indifferent between direct and indirect stock investments vary heavily according to risk aversion, the amounts invested, correlations between assets, transaction costs, and the length of investment horizon. In particular, our results suggest that for a wide range of actively managed mutual funds, the fees charged are too high for these mutual funds to appeal to a wide range of informed investors. However, accounting for search costs, such as costs for financial advice, can facilitate an understanding of the levels of management fees charged by mutual funds existing in the market.

AB - We study the tradeoff between direct and indirect stock investmentsthrough equity mutual funds for a utility-maximizing investor. Whereas directinvestments impose higher transaction costs on the formation of a well-diversified portfolio, mutual funds charge fees for their services. Our results show that the fee levels that make private investors indifferent between direct and indirect stock investments vary heavily according to risk aversion, the amounts invested, correlations between assets, transaction costs, and the length of investment horizon. In particular, our results suggest that for a wide range of actively managed mutual funds, the fees charged are too high for these mutual funds to appeal to a wide range of informed investors. However, accounting for search costs, such as costs for financial advice, can facilitate an understanding of the levels of management fees charged by mutual funds existing in the market.

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KW - Mutual funds

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KW - Transaction costs

KW - Diversification

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