Limited Consideration in the Investment Fund Choice

This study characterizes the household’s choice of investment fund as a multiple step procedure. Using two structural econometric models, I estimate potential investor characteristics that drive the decision process. While the first step includes choosing whether to invest in a fund or not, i.e. it models the extensive margin, the second step models the intensive margin, depending on the choice of the econometric model. In the first step, the probability of becoming a fund investor rises with the level of education, financial literacy and wealth, but falls with age and indebtedness. In the second step, the investment size increases with wealth and age but decreases with financial literacy. Further, I model the choice between different types of investment funds as extensions of the Random Utility Model (RUM) - representing full consideration - and the Limited Consideration Model. In this way, I am able to estimate and compare resulting models. I reject full consideration in favor of limited consideration behavior. Using a novel framework for investment fund choice, I estimate average monetary losses affected by limited consideration. In contrast to previous research that uses only the full consideration framework, I find that all households across the wealth distribution face significant losses. However, conditional on wealth, households with a lower level of education or financial literacy face larger losses. In addition, by combining results from multiple steps of the investment decision, I calculate the elasticity of marginal utility of investing in variables such as financial literacy.