Do Financial Experts Make Better Investment Decisions?

Andriy Bodnaruk

University of Notre Dame – Mendoza College of Business

Andrei Simonov

Michigan State University – Eli Broad Graduate School of Management; Centre for Economic Policy Research (CEPR); Gaidar Institute for Economic Policy; SITE

October 7, 2014

Journal of Financial Intermediation, Forthcoming


We provide direct evidence on the effect of financial expertise on investment outcomes by analyzing private portfolios of mutual fund managers. We find no evidence that financial experts make better investment decisions than peers: they do not outperform, do not diversify their risks better, and do not exhibit lower behavioral biases. Managers do much better in stocks for which they have an information advantage over other investors, i.e., stocks that are also held by their mutual funds. More experienced managers seem to be aware of the limitations to their investment skills as they increase their holdings of mutual fund-related stocks following poor performance of their portfolios. Our results suggest that there are limits to the value added by financial expertise.

Do Financial Experts Make Better Investment Decisions?

The general consensus in the academic literature is that a vast majority of individual investors would be better off putting their money in an index fund.1 Poor investment decisions by individual investors are often blamed on their lack of financial sophistication, defined as the ability to avoid making investment mistakes (Calvet, Campbell, and Sodini, 2009). Indeed, sophistication has been related to higher stock market participation (Mankiw and Zeldes, 1991, Haliassos and Bertaut, 1995, Vissing-Joergensen, 2003, Christiansen, Schroter-Joense, and Rangvid, 2008, Grinblatt, Keloharju, and Linnainmaa, 2011); broader portfolio diversification (Goetzman and Kumar, 2008, Calvet et al., 2007); better performance (Seru, Shumway, and Stoffman, 2010, Grinblatt et al., 2012); and reduced behavioral biases (Feng and Seasholes, 2005, Calvet et al., 2009).

Investors may avoid mistakes by having high cognitive abilities and /or by having financial expertise, where the latter is defined as a comprehensive knowledge of financial markets based on prolonged experience through practice and education. While one does not preclude the other, proxies, used in the literature to identify more financially sophisticated investors, appear to be good at capturing investors’ general intelligence, but do not seem to measure financial expertise well.

In this paper we provide direct evidence on the effect of financial expertise on investment outcomes. We identify a group of individual investors who have the extensive knowledge of finance attained through prior training and day-to-day experience with financial markets: mutual fund managers.3 We compare private investment decisions by these financial experts to those made by individual investors which are similar to them along a number of socio-economic characteristics, but presumably lack financial expertise. We observe personal portfolios of 84 mutual fund (MF) managers in Sweden, as well as the portfolios of their mutual funds and peer individual investors. We have for these managers information on their real estate, total wealth, and personal characteristics.

We find that financial experts do not exhibit superior security-picking ability in their own portfolios. Private investments of fund managers perform on par with investments of investors similar to them in terms of age, sex, education level, income, and wealth. Even more striking, mutual funds managers’ investments perform more poorly than the private investments of the wealthiest 1% of investors.

Our financial experts (mutual fund managers) are likely to have superior access to information and/or analysis about certain companies gained in the course of their work. To disentangle the effect of financial expertise from that of information advantage we conduct the following robustness analysis.We reason that if a security is held by the mutual fund run by manager, ceteris paribus he is more likely to have information advantage in that security. To control for these information differences, we split portfolios of managers into positions that are held by the mutual fund of the manager (MF-related), and those which are not (non-MF-related) and investigate them separately.

Financial Experts

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