Individual Investing

Is individual investing truly a tale of woeful mistakes and biases? In their March 2012 paper entitled “No Skill, Mere Luck? – An Analysis of Individual Investors’ Investment Performance”, Andreas Hackethal, Steffen Meyer, Dennis Schmoltzi and Christian Stammschulte apply bootstrapping simulations based on actual portfolios to distinguish skill from luck among a sample of individual German investors. They use a four-factor model (market, size, book-to-market and momentum) to estimate risk-adjusted performance (alpha). Using weekly gross and net portfolio returns for 8,621 retail investors employing a German online broker during September 2005 through April 2010 (242 weeks), they find that: Keep Reading

How overconfident are individual investors, and how does overconfidence affect their investing practices? In his November 2011 paper entitled “Financial Overconfidence Over Time | Foresight, Hindsight, and Insight of Investors”, Christoph Merkle examines relationships between the return/risk expectations of affluent, self-directed private investors and their trading activity, diversification and risk taking. To frame the relationships, he considers three elements of overconfidence:

1. Overplacement: “I am better informed, more experienced and more skillful in investing than average.”
2. Overprecision: Confidence intervals for expectations are too narrow (expected volatility is too low).
3. Overestimation: Recollected performance is higher than actual performance.

Using quarterly survey data (617 total respondents, with at least 130 in each of nine rounds) and associated investment portfolio characteristics/activity (49,372 trades) for several hundred investors having online brokerage accounts with a UK bank between June 2008 and December 2010, he finds that: Keep Reading

How do individual investors adjust trading behaviors during bull and bear markets? Are any such adjustments advantageous? In their December 2011 paper entitled “Don’t Confuse Brains with a Bull Market: Attribution Bias, Market Condition, and Trading Behavior of Individual Investors”, Zhen Shi and Na Wang examine the trading behaviors of individual investors during different market conditions. They apply a regime switching model to the Chinese stock market to identify: a normal market during January 2005 through August 2006; a bull market during September 2006 through October 2007; and, a bear market during November 2007 through November 2008. They define excessiveness of trading based on two measures: (1) the performance of stocks bought versus that of stocks sold; and, (2) the relationship between portfolio turnover and performance. Using the trading records of 15,040 randomly selected individual Chinese investors during January 2005 through November 2008 (2,357,959 trades), they find that: Keep Reading

Do futures day traders make money? In the March 2011 version of their paper entitled “Overconfident Individual Day Traders: Evidence from a Natural Experiment”, Wei-Yu Kuo and Tse-Chun Lin investigate overconfidence and performance of day traders in the Taiwan futures market. They identify day trades as those committed to close on the same day as a condition of enjoying halved margin deposits. Using complete Taiwan Futures Exchange trading records in Taiwan dollars (TWD) during October 8, 2007 through September 30, 2008 (348,000 trades associated with 3,470 individual day traders who conduct more than 5 day trades), they find that: Keep Reading

How do individual investors respond to an offer of free, unbiased investment advice? In their August 2010 paper entitled “Is Unbiased Financial Advice To Retail Investors Sufficient? Answers from a Large Field Study”, Utpal Bhattacharya, Andreas Hackethal, Simon Kaesler, Benjamin Loos and Steffen Meyer evaluate the responses of 8,195 randomly selected active and likely self-directed individual clients of a large European broker to an offer of free advice. This advice, unbiased in that it is free of monetary incentives for the broker, consists of personalized written and verbal guidance on mean-variance optimization of the client’s existing portfolio based on the client’s risk tolerance, wealth and investment horizon. The broker initiated the offer via email, with telephone follow-ups by an advisor to non-respondents. Using portfolio holder characteristics and daily portfolio holdings/price data from September 2005-May 2009 pre-offer, May 2009-October 2009 offer and post-offer measurement intervals (through March 2010), along with advised portfolio adjustments, they find that: Keep Reading

Do distinct neural processes for rewards and punishments result in distinct variation in learning about financial gains and financial losses? If so, is such variation material to wealth-building? In their September 2011 paper entitled “Gain and Loss Learning Differentially Contribute to Life Financial Outcomes”, Brian Knutson, Gregory Samanez-Larkin and Camelia Kuhnen examine whether individual differences in gain learning and loss learning relate distinctly to cumulative financial outcomes. Specifically, they relate gain and loss learning separately to self-reported measures of assets and debts (as partially corroborated by credit reports), controlling for other potentially confounding individual characteristics. Using results of a financially incentivized learning experiment involving a representative sample of 75 San Francisco area residents, they find that: Keep Reading

Is fine wine a good investment? Two recent studies are on the case. In their February 2010 paper entitled “Raise your Glass: Wine Investment and the Financial Crisis”, Philippe Masset and Jean-Philippe Weisskopf examine the risk, return and diversification benefits of fine wine. In their August 2011 paper entitled “Is Wine a Premier CRU Investment?”, Liam Devine and Brian Lucey investigate Bordeaux and Rhone wines as investments. Both studies employ repeat-sales regressions from auctions via The Chicago Wine Company to construct wine price indexes. Using wine auction prices and other sources of wine returns from as early as January 1996, they find that: Keep Reading

What does the body of academic research say about the stock trading behaviors and outcomes for individual investors? In their June 2011 paper entitled “The Behavior of Individual”, Brad Barber and Terrance Odean survey four areas of empirical research on the behavior of individual investors trading individual stocks: (1) performance, (2) the disposition effect, (3) buying behavior and (4) diversification. Using the findings of many studies performed over the last three decades, they conclude that: Keep Reading

Do gems offer good returns? How do the returns of these tangible assets compare with those of other asset classes? In the April 2011 version of their paper entitled “Hard Assets: The Returns on Rare Diamonds and Gems”, Luc Renneboog and Christophe Spaenjers examine recent returns on precious gems in U.S. dollars. They concentrate on the upper end of gem quality for three categories: white diamonds, colored diamonds and other gems (emeralds, rubies and sapphires). They consider gem attributes such as weight, color, clarity, cut, location of sale, auction house, brand and certification as allowed by subsample sizes. Using worldwide auction data spanning 1999 (the first year of representative coverage in the source database) through 2010 (3,952 total sales), along with the contemporaneous values of the U.S. Consumer Price Index and returns for other worldwide asset markets, they find that: Keep Reading

How effective are tax-deferred savings in avoiding federal income taxes over a lifetime? In their May 2011 paper entitled “The Tax Benefit of Income Smoothing”, Kristian Rydqvist, Steven Schwartz and Joshua Spizman estimate the lifetime benefit of postponing federal income tax liability until retirement by contributing pre-tax dollars to individual or employer-sponsored retirement savings while working. They quantify the benefit as the reduction in average annual lifetime federal income tax rate. They assume a base case of 40 work years (ages 25-65) and a number of retirement years equal to life expectancy minus 65. Using the complete time-series of U.S. income tax history (with focus on 2010 tax tables), they find that: Keep Reading