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Learning by Individual Investors

Posted in Individual Investing

Does experience improve individual investing performance? In the August 2012 version of their paper entitled “Do Individual Investors Learn from Their Mistakes?”, Maximilian Koestner, Steffen Meyer and Andreas Hackethal examine whether investors learn to avoid portfolio underdiversification, overconfidence (overtrading) and the disposition effect (selling winners and holding losers). They consider three measures of investor experience: cumulative number of trades initiated; number of months with at least one trade; and, cumulative number of securities traded. Using complete trading histories, demographics and other characteristics for 19,487 German retail investors during January 2000 through December 2007, they find that:

  • Investors in the sample tend to be male, about 40 years old, self-directed regarding investment choices and near the beginning of their investing lives.
  • As investors gain experience, their investment performance improves, with 100 incremental trades associated with a 0.15% increase in monthly portfolio performance.
    • Improvement derives largely from declining portfolio turnover, with 100 incremental trades associated with 0.8% lower monthly turnover (average monthly turnover is 16.2%).
    • Experience does not mitigate underdiversification or the disposition effect. If anything, experience exacerbates these two investor mistakes.
  • Findings are robust across types of investors, market environments and investment styles.

In summary, evidence indicates that investors learn to trade less as they gain experience, perhaps due to the immediate feedback associated with transaction costs, but they do not learn to diversify or avoid the disposition effect.

One caution regarding findings is that the sample may not be representative of other types of investors.

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