common stock 3

8/17/2019 Common Stock 3

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Trading Is Hazardous to Your Wealth: The Common

Stock Investment Performance of Individual Investors

Authors

• Brad M. Barber,

• Terrance Odean

• First pulished: April 2000Full publication history

• !"I: 10.1111/0022-1082.0022!ie"/sa#e citation• Cited #: 1$ articles%e&resh citation count'itin( literature

•

• )raduate *chool o& Mana(e+ent, ni#ersity o& 'ali&ornia, a#is. e are (rate&ul to the discount broera(e

&ir+ that pro#ided us "ith the data &or this study. e appreciate the co++ents o& 'hristopher Barry, )eor(eBittlin(+ayer, u(ene Fa+a, en French, aurie ri(+an, Bin( ian(, 3ohn 4o&sin(er, *rini#asan %an(an, Mar%ubinstein, %en5 *tul6 7the editor, A#anidhar *ubrah+anya+, ent o+ac, 3ason 9"ei(, t"o anony+ousre#ie"ers, se+inar participants at the A+erican Finance Association Meetin(s 74e" :or, 1$$$, the $th Annual'on&erence on Financial cono+ics and Accountancy at 4e" :or ni#ersity, 4otre a+e ni#ersity, theni#ersity o& ;llinois, and participants in the 'o+puser#e ;n#estor Foru+. All errors are our o"n.

Abstract

;ndi#idual in#estors "ho hold co++on stocs directly pay a tre+endous per&or+ance penalty &or acti#e tradin(. O& ,.$ percent. The a#era(e household earns an annual return o& 1.< percent, tilts its co++on stocin#est+ent to"ard hi(h-beta, s+all, #alue stocs, and turns o#er >= percent o& its port&olio

annually. O#ercon&idence can e?plain hi(h tradin( le#els and the resultin( poor per&or+ance o&indi#idual in#estors. Our central +essa(e is that tradin( is ha6ardous to your "ealth.

Provide feedback or get helpThe investor's chief problem—and even his worst

enemy—is likely to be himself .Ben@a+in )raha+

;n 1$$, appro?i+ately percent o& euity in#est+ents in

the nited *tates "ere held directly by households, 2 percent by pension &unds, and 1< percent by +utual&unds (Securities Industry Fact Book , 1$$>. Financial econo+ists ha#ee?tensi#ely analy6ed the return per&or+ance o& euities+ana(ed by +utual &unds. There is also a &air a+ount o&

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research on the per&or+ance o& euities +ana(ed by pension&unds. n&ortunately, there is little research on the return per&or+ance o& euities held directly by households, despite

their lar(e o"nership o& euities.;n this paper, "e atte+pt to shed li(ht on the in#est+ent per&or+ance o& co++on stocs held directly by households.To do so, "e analy6e a uniue data set that consists o& position state+ents and tradin( acti#ity &or >8,000households at a lar(e discount broera(e &ir+ o#er a si?-year period endin( in 3anuary 1$$>.

Our analyses also allo" us to test t"o co+petin( theories o&tradin( acti#ity. sin( a rational e?pectation&ra+e"or, $rossman and Stiglitz %&'()* ar(ue thatin#estors "ill trade "hen the +ar(inal bene&it o& doin( so iseual to or e?ceeds the +ar(inal cost o& the trade. ;ncontrast "dean %&''(*, $ervais and "dean %&''(*,

and Caall+ and S,kovics %&''(* de#elop theoretical+odels o& &inancial +arets "here in#estors su&&er &ro+o#ercon&idence. These o#ercon&idence +odels predict thatin#estors "ill trade to their detri+ent.1

Our +ost dra+atic e+pirical e#idence supports the #ie" thato#ercon&idence leads to e?cessi#e tradin( 7see Fi(ure 1. Onone hand, there is #ery little di&&erence in the (ross

per&or+ance o& households that trade &reuently 7"ith+onthly turno#er in e?cess o& 8.8 percent and those thattrade in&reuently. ;n contrast, households that trade&reuently earn a net annuali6ed (eo+etric +ean return o&11.< percent, and those that trade in&reuently earn 18.=

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percent. These results are consistent "ith +odels "heretradin( e+anates &ro+ in#estor o#ercon&idence, but areinconsistent "ith +odels "here tradin( results &ro+ rational

e?pectations. Thou(h liuidity, ris-based rebalancin(, andta?es can e?plain so+e tradin( acti#ity, "e ar(ue that it belies co++on sense that these +oti#ations &or trade, e#en inco+bination, can e?plain a#era(e annual turno#er o& +orethan 2=0 percent &or those households that trade +ost.e also docu+ent that, o#erall, the households "e analy6esi(ni&icantly underper&or+ rele#ant bench+ars, a&ter a

reasonable accountin( &or transaction costs. Thesehouseholds earn (ross returns 7be&ore accountin( &ortransaction costs that are close to those earned by anin#est+ent in a #alue-"ei(hted inde? o& 4:*/AMC/4asda stocs. urin( our sa+ple period, anin#est+ent in a #alue-"ei(hted +aret inde? earns anannuali6ed (eo+etric +ean return o& 1>.$ percent, the

a#era(e household earns a (ross return o& 18.> percent, andin a((re(ate households earn a (ross return o& 18.2 percent.;n contrast, the net per&or+ance 7a&ter accountin( &or the bidas spread and co++issions o& these households is belo" par, "ith the a#era(e household earnin( 1.< percentand in a((re(ate households earnin( 1.> percent. Thee+pirical tests supportin( these conclusions co+e &ro+

abnor+al return calculations that allo" each household tosel&-select its o"n in#est+ent style and &ro+ ti+e-seriesre(ressions that e+ploy either the 'apital Asset Dricin(Model 7'ADM or the three-&actor +odel de#eloped by Fama and French %&''-* as our bench+ar.

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Figure &.• Open in &i(ure #ie"er

• o"nload Do"erpoint slide

Monthly turno#er and annual per&or+ance o& indi#idual in#estors.

The "hite bar 7blac bar represents the (ross 7net annuali6ed(eo+etric +ean return &or February 1$$1 throu(h 3anuary 1$$> &orindi#idual in#estor uintiles based on +onthly turno#er, the a#era(eindi#idual in#estor, and the *ED =00. The net return on the *ED =00;nde? Fund is that earned by the !an(uard ;nde? =00. The (ray barrepresents the +onthly turno#er.

Our descripti#e analysis pro#ides se#eral additionalconclusions that are note"orthy

• 1.Gouseholds2 trade co++on stocs &reuently. The a#era(e household turns o#er +ore

than >= percent o& its co++on stoc port&olio annually.

• 2.Tradin( costs are hi(h. The a#era(e round-trip trade in e?cess o& H1,000 costs three

percent in co++issions and one percent in bid-as spread.

• .Gouseholds tilt their in#est+ents to"ard s+all, hi(h-beta stocs. There is a less ob#ious

tilt to"ard #alue 7hi(h boo-to-+aret stocs.

;t is the cost o& tradin( and the &reuency o& tradin(, not

port&olio selections, that e?plain the poor in#est+ent per&or+ance o& households durin( our sa+ple period. ;n &act,the tilt o& households to"ard s+all stocs and, to a lessere?tent, #alue stocs helps their per&or+ance durin( oursa+ple period 7durin( "hich s+all stocs outper&or+ lar(estocs by 1= basis points per +onth and #alue outper&or+s(ro"th by 20 basis points per +onth.

The re+ainder o& this paper is or(ani6ed as &ollo"s. ediscuss related research in *ection ; and our data ande+pirical +ethods in *ection ;;. Our +ain descripti#e resultsare presented in *ection ;;;. e test the +odels o& in#estoro#ercon&idence in *ection ;!. e discuss the i+pact o& price

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+o+entu+ on indi#idual in#estor per&or+ance in *ection !and liuidity, ris, and ta?es as +oti#ations &or tradin( in*ection !;. 'oncludin( re+ars are +ade in *ection !;;.

I. /elated /esearchTo our no"led(e, the current in#esti(ation is the &irstco+prehensi#e study o& the a((re(ate co++on stoc per&or+ance o& indi#idual in#estors "ho +ana(e their o"neuity in#est+ents "ithout the ad#ice o& a &ull-ser#ice broer. Schlaraum0 1e2ellen0 and 1ease %&'3(a* analy6e

the a((re(ate co++on stoc per&or+ance o& in#estors at a&ull-ser#ice broera(e &ir+. "dean %&'''* and Schlaraum01e2ellen0 and 1ease %&'3(* analy6e the pro&itability o&co++on stoc trades 7as distinct &ro+ positions held byindi#idual in#estors.Schlaraum et al. %&'3(a* calculate +onthly (ross and net port&olio returns &or 2,=00 accounts at a retail broera(e &ir+

o#er a se#en-year period endin( in ece+ber 1$>0. ;n aseparate paper, Schlaraum et al. %&'3(* analy6e the (rossand net returns o& round-trip trades +ade by the sa+e 2,=00accounts o#er the sa+e period. Thou(h they e+phasi6e thattheir results are con@ectural, they conclude that their resultsIportray an o#erall picture o& uite respectable indi#idualin#estor security selection acu+en.J ;n contrast, "e

docu+ent that indi#idual in#estors at a discount broera(e&ir+ durin( the si?-year period endin( 3anuary 1$$> per&or+ poorly.There are at least three reasons "hy our results +i(ht di&&er&ro+ those in Schlaraum et al. %&'3(a, &'3(. First, "e

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analy6e households that hold their in#est+ents at a discount broera(e &ir+ rather than at a retail broera(e &ir+. A "ide#ariety o& in#est+ent ad#ice is a#ailable to both retail and

discount in#estors &ro+ sources such as ne"sletters, Value ine,and the &inancial press. %etail broera(e &ir+s also pro#idestoc selection ad#ice to their clients. ;& this ad#ice is#aluable and i& in#estors attend to it, it is plausible thatindi#idual in#estors at these &ir+s earn both better (rossreturns and net returns. e "ould "elco+e the opportunityto test this hypothesis directly by obtainin( a data set si+ilar

to that e+ployed in our study &ro+ a retail broera(e&ir+. 4arer et al. %&''(* and Womack %&''5* presente#idence that the reco++endations o& broera(e-houseanalysts ha#e in#est+ent #alue.*econd, the analysis in Schlaraum et al. %&'3(* &ocuseson the returns &ro+ round-trip trades. There is no" e#idencethat in#estors ha#e a tendency to sell "innin( in#est+ents

and hold on to losin( in#est+ents 7"dean %&''(a*. Thus, byanaly6in( trades rather than position state+ents 7as "e do inthe current study, *chlarbau+ et al. +ay up"ardly bias their return esti+ates. Schlaraum et al. %&'3(a* do atte+pt toreconstruct +onthly positions &ro+ tradin( records and partial end-o&-period positions. Go"e#er, as they point out,stocs purchased be&ore 1$< and sold a&ter 1$>0 +ay not

appear in their study.Third, althou(h Schlaraum et al. %&'3(a, &'3( e#aluate per&or+ance usin( a #ariety o& +aret inde?es, they do notconsider the tendency &or indi#idual in#estors to tilt to"ards+all stocs 7thou(h o& course &ir+ si6e did not ha#e the

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sa+e celebrity status in 1$>8 that it en@oys today. They donot e?plicitly address "hether such a tilt e?ists a+on( theindi#idual in#estors they analy6e, but "e suspect that it does.

This s+all-stoc tilt is liely to be e?tre+ely i+portant because s+all stocs outper&or+ lar(e stocs by > basis points per month durin( their sa+ple period.As do Schlaraum et al. %&'3(*, "dean %&'''* &ocuses onthe trades o& indi#idual in#estors. Ge analy6es the ti+in( o&trades +ade by indi#idual in#estors at a lar(e discount broera(e &ir+ durin( the se#en years endin( in ece+ber

1$$, a sa+ple period that o#erlaps "ith ours. 7The data setse+ployed in "dean %&'''* and this study are di&&erent. Gedocu+ents that the stocs indi#iduals sell subseuentlyoutper&or+ the stocs they buy. Thus, the i+plications o& hisstudy and the current in#esti(ation are si+ilar ;ndi#idualin#estors trade too +uch. Go"e#er, Odean does not analy6ethe a((re(ate per&or+ance o& all stocs held by indi#iduals.

'onseuently, he is unable to conclude "hether indi#idualin#estors per&or+ "ell in a((re(ate, "hich is the &ocus o& our in#esti(ation.

II. !ata and 6ethods

7. Household 7ccount !ata

The pri+ary data set &or this research is in&or+ation &ro+ alar(e discount broera(e &ir+ on the in#est+ents o& >8,000households &ro+ 3anuary 1$$1 throu(h ece+ber 1$$.


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*outh, and 1= percent in the Mid"est. The data set includesall accounts opened by each household at this discount broera(e &ir+. The sa+ple selection "as per&or+ed at the

household le#el and "as strati&ied based on "hether thediscount broera(e &ir+ labeled the household as a (eneral70,000 households, a&&luent 712,000 households, or acti#etrader household 7,000 households. The &ir+ labelshouseholds that +ae +ore than


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11 percent ha#e +ore than three. The +ost co++on reason&or t"o accounts is the ta?-pre&erred status o& retire+entaccounts 7e.(., ;%As and eo(hs. *o+e households also

ha#e di&&erent accounts &or di&&erent household +e+bers7e.(., custodial accounts &or children. %ou(hly 0 percent o&the +aret #alue in the accounts is held in co++on stocs.;n these households, +ore than +illion trades are +ade inall securities durin( the sa+ple period, "ith co++on stocsaccountin( &or sli(htly +ore than 0 percent o& all trades. Ona#era(e durin( our sa+ple period, the +ean household holds


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7.0> percent.

The sa+ple is account records &or ,=thDercentile

*tandarde#iation

Danel A Durchases

Trade si6e 7H 11,20= 2,=1 $

Drice/share 1.0 11.00 2.00 .82

Monthly

turno#er 7N

. >.08 11.8$

'o++ission7NL

1.=8 0.>8 1.2$ 2.10 1.0> 2,88 =,>8 1,000 8,2>=

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Drice/share 1.22 12.00 2

Danel Trade-ei(hted *ales

A((re(ate+onthlyturno#er 7N

.0

Trade-"ei(htedco++ission 7N

0. 4ot applicable

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Trade-"ei(htedspread 7N

0.1

For each trade, "e esti+ate the bid-as spread co+ponent o&transaction costs &or purchases (sprdb)7sprdb and sales (sprds)7sprds as

sprds=(PcldsPsds−1)andsprdb=−(PcldbPbdb−1),sprds7DdsclDdss1andsprdb7DdbclDdbb1,71

"here PcldsDdscl and PcldbDdbcl are the reported closin( prices &ro+the 'enter &or %esearch in *ecurity Drices 7'%*D dailystoc return &iles on the day o& a sale and purchase,

respecti#ely, andPsdsDdss

andPbdbDdbb

are the actual sale price and purchase price &ro+ our account database.= Our esti+ate o&the bid-as spread co+ponent o& transaction costs includesany +aret i+pact that +i(ht result &ro+ a trade. ;t alsoincludes an intraday return on the day o& the trade.7;n Appendi? A, "e pro#ide a detailed reconciliation o& ourreturn calculations. The co++ission co+ponent o&

transaction costs is esti+ated as the dollar #alue o& theco++ission paid scaled by the total principal #alue o& thetransaction, both o& "hich are reported in our account data.The a#era(e purchase costs an in#estor 0.1 percent, and thea#era(e sale costs an in#estor 0.$ percent in bid-as spread.Our esti+ate o& the bid-as spread is #ery close to the tradin(cost o& 0.21 percent &or purchases and 0. percent &or sales

paid by open-end +utual &unds &ro+ 1$ to 1$$ 7Carhart%&''3*. The a#era(e purchase in e?cess o& H1,000 costs1.=8 percent in co++issions, and the a#era(e sale in e?cesso& H1,000 costs 1.

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;n Danels ' and o& Table ;, "e calculate the trade-"ei(hted7"ei(hted by trade si6e spreads and co++issions. These&i(ures can be thou(ht o& as the total cost o& conductin( the

H2< billion in co++on stoc trades 7H12 billion each in purchases and sales. Trade si6e has little e&&ect on spreadcosts 70.2> percent &or purchases and 0.$ percent &or sales but substantially reduces the co++ission costs 70.>> percent&or purchases and 0. percent &or sales.;n su+, the a#era(e trade incurs a round-trip transaction costo& about one percent &or the bid-as spread and about three

percent in co++issions. ;n a((re(ate, round-trip trades costabout one percent &or the bid-as spread and about 1.< percent in co++issions.

Finally, "e calculate the +onthly port&olio turno#er &or eachhousehold. ;n each +onth durin( our sa+ple period, "eidenti&y the co++on stocs held by each household at the

be(innin( o& +onth t &ro+ their position state+ents. Tocalculate +onthly sales turno#er, "e +atch these positions tosales durin( +onth t . The +onthly sales turno#er iscalculated as the shares sold ti+es the be(innin(-o&-+onth price per share di#ided by the total be(innin(-o&-+onth+aret #alue o& the householdPs port&olio. To calculate+onthly purchase turno#er, "e +atch these positions to

purchases durin( +onth t−1t1. The +onthly purchaseturno#er is calculated as the shares purchased ti+es the be(innin(-o&-+onth price per share di#ided by the total be(innin(-o&-+onth +aret #alue o& the port&olio.8 ;n DanelsA and B o& Table ; "e report that, on a#era(e, households

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purchase . percent o& their stoc

port&olio and sellin( 2.=8 percent. ;n Danels ' and , "ecalculate a((re(ate purchase 7sales turno#er by su++in( all purchases 7sales and di#idin( by the su+ o& all positionsdurin( our sa+ple period. The a((re(ate purchase turno#er is.0= percent and the a((re(ate sales turno#er is .0 percent.;n su+, these in#estors trade their co++on stocs uite&reuently. The a#era(e household turns o#er +ore than >=

percent o& its co++on stoc port&olio each year. This resultis uncannily close to the a#era(e turno#er o& >> percentreported by .*. co++on stoc +utual &unds &or the period1$ to 1$$ 7Carhart %&''3*. ;n a((re(ate, these in#estorsturn o#er +ore than >0 percent o& their in#ested "ealth eachyear.

4. 6easuring /eturn Performance

The &ocus o& our analysis is the return per&or+ance o&in#est+ents in co++on stocs by households. e analy6e both the (ross per&or+ance and net per&or+ance 7a&ter areasonable accountin( &or co++issions, the bid-as spread,and the +aret i+pact o& trades.

e esti+ate the (ross +onthly return on each co++on stoc in#est+ent usin( the be(innin(-o&-+onth position state+ents&ro+ our household data and the '%*D +onthly returns &ile.;n so doin(, "e +ae t"o si+pli&yin( assu+ptions. First, "eassu+e that all securities are bou(ht or sold on the last day o&

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the +onth. Thus, "e i(nore the returns earned on stocs purchased &ro+ the purchase date to the end o& the +onthand include the returns earned on stocs sold &ro+ the sale

date to the end o& the +onth. *econd, "e i(nore intra+onthtradin( 7e.(., a purchase on March and a sale o& the sa+esecurity on March 20, thou(h "e do include in our analysisshort-ter+ trades that yield a position at the end o& a calendar +onth.

;n Appendi? A, "e docu+ent that accountin( &or the e?act

ti+in( o& trades "ould reduce the per&or+ance o& indi#idualin#estors by about t"o basis points per +onth. ;n Appendi?B, "e docu+ent that accountin( &or intra+onth trades "ouldi+pro#e the per&or+ance o& indi#idual in#estors reported inour +ain results by less than one basis point per +onth.More i+portant, a care&ul accountin( &or both the e?actti+in( o& trades and the pro&itability o& intra+onth trades

indicates that the results "e report in the +ain te?t aresli(htly hi(h &or our &ull sa+ple and &or e#ery sa+ple partition that "e analy6e.'onsider the co++on stoc port&olio &or a particularhousehold. The (ross +onthly return on the householdPs port&olio

(Rgrht)7%ht(r72

is calculated as Rgrht=∑i=1shtpitRgrit,%ht(rQi1shtpit%it(r, "here pit is the

be(innin(-o&-+onth +aret #alue &or the holdin( o&stoc i by household h in +onth t di#ided by the be(innin(-o&-+onth +aret #alue o& all stocs held by

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by the be(innin(-o&-+onth +aret #alue o& co++on stocheld by all households. e esti+ate the (ross and net+onthly return earned by the a#era(e household as

RHgrt=1nht∑nhth=1RgrhtandRHnett=1nht∑nhth=1Rnetht.%Gt(r1nhtQh1nht%ht(rand%Gtnet1nhtQh1nht%htnet.7

C. /isk87d9usted /eturn

Performance

e calculate &our +easures o& ris-ad@usted per&or+ance.$ First, "e calculate an o"n-bench+ar

abnor+al return &or indi#idual in#estors, "hich is si+ilar inspirit to that proposed by $rinlatt and Titman%&''-* and 1akonishok0 Shleifer0 and ishn# %&'';*. ;nthis abnor+al return calculation, the bench+ar &orhousehold h is the +onth t return o& the be(innin(-o&-year port&olio held by household h.10 ;t represents the return thatthe household "ould ha#e earned had it +erely held its

be(innin(-o&-year port&olio &or the entire year. The o"n- bench+ar abnor+al return is the return earned byhousehold h less the o"n-bench+ar returnK i& the householddid not trade durin( the year, the o"n-bench+ar return is6ero &or all 12 +onths durin( the year. ;n each +onth, theabnor+al returns across households are a#era(ed, yieldin( a>2-+onth ti+e-series o& +ean +onthly o"n-bench+ar

abnor+al returns. *tatistical si(ni&icance is calculated usin(t-statistics based on this ti+e-series. The ad#anta(e o& theo"n-bench+ar abnor+al return +easure is that it does notad@ust returns accordin( to a particular ris +odel. 4o +odelo& ris is uni#ersally acceptedK &urther+ore, it +ay be

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inappropriate to ad@ust in#estorsP returns &or stoccharacteristics that they do not associate "ith ris. The o"n- bench+ar +easure allo"s each household to sel&-select the

in#est+ent style and ris pro&ile o& its bench+ar 7i.e., the port&olio it held at the be(innin( o& the year, thuse+phasi6in( the e&&ect tradin( has on per&or+ance.*econd, "e calculate the +ean +onthly +aret-ad@ustedabnor+al return &or indi#idual in#estors by subtractin( thereturn on a #alue-"ei(hted inde? o& 4:*/AMC/4asdastocs &ro+ the return earned by indi#idual in#estors.

Third, "e e+ploy the theoretical &ra+e"or o& the capitalasset pricin( +odel and esti+ate 3ensenPs alpha by re(ressin(the +onthly e?cess return earned by indi#idual in#estors onthe +aret e?cess return. For e?a+ple, to e#aluate the (ross+onthly return earned by indi#idual in#estors in a((re(ate,"e esti+ate the &ollo"in( +onthly ti+e-series re(ression

(RAGgrt−Rft)=αi+βi(Rmt−Rft)+ϵit,7%A)t(r%&tSiRi7%+t%&tR it,ϵ 7>

"here # ft the +onthly return on T-bills,11 #mt the +onthlyreturn on a #alue-"ei(hted +aret inde?, S i the 'ADMintercept 73ensenPs alpha, i the +aret beta, and ϵit there(ression error ter+. The subscript i denotes para+eteresti+ates and error ter+s &ro+ re(ression i, "here "e

esti+ate &our re(ressions one each &or the (ross and net per&or+ance o& indi#idual in#estors in a((re(ate, and oneeach &or the (ross and net per&or+ance o& the a#era(ehousehold.

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Fourth, "e e+ploy an intercept test usin( the three-&actor+odel de#eloped by Fama and French %&''-*. Fore?a+ple, to e#aluate the per&or+ance o& indi#iduals in

a((re(ate, "e esti+ate the &ollo"in( +onthly ti+e-seriesre(ression(RAGgrt−Rft)=α j+β j(Rmt−Rft)+s jSMBt+h jHMLt+ϵ jt,7%A)t(r%&tS@R@7%+t%&t

Rs@*MBtRh@GMtR @t,ϵ 78

"here S$Bt is the return on a #alue-"ei(hted port&olio o& s+allstocs +inus the return on a #alue-"ei(hted port&olio o&lar(e stocs and %$t is the return on a #alue-"ei(hted

port&olio o& hi(h boo-to-+aret stocs +inus the return on a#alue-"ei(hted port&olio o& lo" boo-to-+aret stocs.12 There(ression yields para+eter esti+ates o& S &, &, si and h &. Theerror ter+ in the re(ression is denoted by ϵ @t. Thesubscript & denotes para+eter esti+ates and error ter+s &ro+re(ression &, "here "e a(ain esti+ate &our re(ressions. e place particular e+phasis on the Fa+aUFrench intercept

tests, since indi#idual in#estors tilt their port&olios to"ards+all stocs. The three-&actor +odel pro#ides a reasonablead@ust+ent &or this s+all stoc tilt.1

Fama and French %&''-* ar(ue that the ris o& co++onstoc in#est+ents can be parsi+oniously su++ari6ed as risrelated to the +aret, &ir+ si6e, and a &ir+Ps boo-to-+aretratio. e +easure these three ris e?posures usin( the

coe&&icient esti+ates on the +aret e?cess return (Rmt−Rft)7%+t%&t, the si6e 6ero in#est+ent port&olio 7S$Bt , and the boo-to-+aret 6ero-in#est+ent port&olio 7 %$t &ro+ the three-&actor re(ressions. Dort&olios "ith abo#e-a#era(e +aret ris ha#e betas (reater than one, β j>1@V1. Dort&olios "ith a tilt

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to"ard s+all 7#alue stocs relati#e to a #alue-"ei(hted+aret inde? ha#e si6e 7boo-to-+aret coe&&icients (reaterthan 6ero, s j>0(h j>0)s@V07h@V0.

e suspect there is little uibble "ith interpretin( thecoe&&icient on the +aret e?cess return (β j)7@ as a ris &actor.

;nterpretin( the coe&&icient esti+ates on the si6e and the boo-to-+aret 6ero-in#est+ent port&olios is +orecontro#ersial. For the purposes o& this in#esti(ation, "e areinterested in +easurin( ris as percei#ed by indi#idualin#estors. As such, it is our casual obser#ation that in#estors

#ie" co++on stoc in#est+ent in s+all &ir+s as risier thanthat in lar(e &ir+s. Thus, "e "ould "illin(ly accept astron(er tilt to"ard s+all stocs as e#idence that a particular(roup o& in#estors is pursuin( a strate(y that it percei#es asrisier. ;t is less clear to us "hether a tilt to"ard hi(h boo-to-+aret stocs 7"hich tend to be u(ly, &inanciallydistressed, &ir+s or to"ard lo" boo-to-+aret stocs

7"hich tend to be hi(h-(ro"th &ir+s is perceived as risier byin#estors. As such, "e interpret the coe&&icient esti+ates onthe boo-to-+aret 6ero-in#est+ent port&olio "ith a bit +oretrepidation.1<

III. /esults

7. Full Sample /esultsOur +ain &indin(s &or the &ull sa+ple can be su++ari6edsi+ply. The (ross return earned by indi#idual in#estors ina((re(ate (RAGgrt)7%A)t(r and the (ross return earned by the

a#era(e household (RHnett)7%Gtnet are re+arably close to that

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earned by an in#est+ent in a #alue-"ei(hted inde? o& 4:*/AMC/ 4asda stocs.1= The annuali6ed (eo+etric+ean return earned by indi#idual in#estors in a((re(ate, the

a#era(e household, and the #alue-"ei(hted +aret inde? are18.2, 18.>, and 1>.$ percent, respecti#ely. ;n contrast, the netreturns earned by indi#idual in#estors in a((re(ate (RAGnett)

7%A)tnet and the net return earned by the a#era(ehousehold (RHnett)7%Gtnet underper&or+ the #alue-"ei(hted inde?

by +ore than 100 basis points annually. The net annuali6ed(eo+etric +ean return earned by indi#idual in#estors in

a((re(ate and by the a#era(e household are 1.> and 1.< percent, respecti#ely.The results o& this analysis are presented in Table ;;. Danel A presents results &or the (ross per&or+ance o& indi#idualin#estors in a((re(ate, Danel B presents results &or thea#era(e household. Three o& the &our per&or+ance +easuresindicate that the (ross per&or+ance o& indi#idual in#estors is

unre+arableK neither the +aret-ad@usted return, 3ensenPsalpha, nor the intercept test &ro+ the Fa+a-French three-&actor +odel is reliably di&&erent &ro+ 6ero. The &ourth per&or+ance +easure, the o"n-bench+ar abnor+al return,is reliably ne(ati#e. This result indicates that the in#estors"ould ha#e earned hi(her returns &ro+ &ollo"in( a buy-and-hold strate(yK they hurt their ross per&or+ance by tradin(.

Also note"orthy in these results are the coe&&icient esti+ateson the +aret, si6e, and boo-to-+aret &actors. ;ndi#idualin#estors tilt to"ard s+all stocs "ith hi(h +aret ris. The+aret beta &or stocs held by indi#idual in#estors is reliably(reater than one and the coe&&icient esti+ate on S$Bt is

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reliably positi#e. Thou(h in a((re(ate indi#idual in#estorsha#e no tilt to"ard #alue or (ro"th, the a#era(e householdhas a sli(ht tilt to"ard #alue stocs 7those "ith hi(h boo-to-

+aret ratios and a +ore pronounced tilt to"ard s+allstocs.1 These tilts ser#e indi#idual in#estors "ell durin( our period o& analysisK the +ean +onthly returnson S$Bt and %$t durin( our >2-+onth sa+ple period are 0.1=and 0.20 percent, respecti#ely. This obser#ation can account&or the &act that the +aret-ad@usted return per&or+ance o&indi#idual in#estors is positi#e 7albeit unreliably so, "hile

3ensenPs alpha 7'ADM intercept and the intercept test &ro+the Fa+a-French three-&actor +odel are ne(ati#e.The style pre&erences o& indi#idual in#estors co+ple+entthose o& institutions. ;nstitutional in#estors ha#e a clear pre&erence &or lar(e stocs. $ompers and 6etrick%&''(* docu+ent this pre&erence &or lar(einstitutionsK Carhart %&''3* and Falkenstein

%&''5* docu+ent a si+ilar bias &or +utual &unds. As is thecase &or indi#idual in#estors, the (ro"th or #alue pre&erenceo& institutions is less ob#ious. $ompers and 6etrick%&''(* docu+ent that lar(e institutions pre&er #alue stocs, but Carhart %&''3,Table ;;; docu+ents that +utual &undholdin(s tilt to"ard (ro"th stocs.1>Tale II. *u++ary o& the Dercenta(e Monthly Abnor+al %eturn Measures &or the A#era(eGousehold and A((re(ate Gousehold

1. LLL, LL, and L indicate si(ni&icance at the 1, =, and 10 percent le#els, respecti#ely 7t"o-tailed. The null hypothesis &or beta 7

esti+ate on the +aret e?cess return is Ho:β=1Go1.

%eturns are based on +onth-end position state+ents &or ,


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Danel A 7Danel ' presents results &or the (ross 7net return on a port&olio that +i+ics the a((re(ate in#est+ent o& all households. Dane presents results &or the (ross 7net return on a port&olio that +i+ics the in#est+ent o& the a#era(e household. O"n-bench+ar abnor+areturn on the household port&olio +inus the return on the port&olio the household held at the end o& the pre#ious 3anuary. Maret-ad@ustreturn on the household port&olio less the return on a #alue-"ei(hted 4:*/AMC/4asda inde?. 'ADM is the results &ro+ a ti+e-se

the household e?cess return on the +aret e?cess return(Rmt−Rft)7%+t%&t. Fa+a-French three-&actor is the results &ro+ ti+e-serhousehold e?cess return on the +aret e?cess return, a 6ero-in#est+ent boo-to-+aret port&olio %$t , and a 6ero-in#est+ent si6e por#alues are presented in parentheses.

'oe&&icient sti+ate on

?cess%eturn

(Rmt−Rft)7%+t%&t %$t S$Bt Ad@uste

Danel A )ross Dercenta(e Monthly %eturns in A((re(ate

O"n- bench+arabnor+alreturn

0.02

'ADM 0.0> 1.100LLL $2.

70.=

Fa+a-Frenchthree-&actor

0.0> 1.082LLL 0.0= 0.21LLL $.

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70.=> 70.00= 70.2


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Maret-ad@ustedreturn

0.0>

70.> 1.082 80.

70.0 70.1$


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turno#er 7N

'oe&&icient esti+ate on

(Rmt−Rft)7%+t%&t

1.21LLL 1.1LLL 1.11LLL 1.11LLL 1.0LL

70.00 70.0= 70.0>$

S$Bt 0.$>LLL 0.=LLL 0.LLL

70.000 70.000 70.000 70.000 70.000

Ad@usted #2 8.1 $2.8 $.2 $1 0.0=1LL 0.08L 0.08L 0.0>L

70.101 70.022 70.0>0 70.01 70.0>>

http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-note-0003


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Maret-ad@usted return 0.02 0.0$1 0.0= 0.00< 0.020

70.>0 70.== 70.$80 70.8=>

'ADM intercept 0.182 0.01= 0.02

70.12 70.$0 70.= 0.1=2 0.1


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70.8>= 70.=0 70.2


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the >2 +onths. hen "e co+pare the per&or+ance o&indi#idual in#estors durin( the 20 +onths "hen the +aret"as do"n to the =2 +onths in "hich the +aret "as up, the

per&or+ance +easures presented in Table ;; are #irtuallyidentical.

4. Sorting on Portfolio Size

e test the robustness o& our results across di&&erent positionsi6es by partitionin( the households into uintiles on the basis o& port&olio si6e. e de&ine port&olio si6e as the +aret

#alue o& co++on stocs held in the &irst +onth &or "hichthere is a position state+ent.18 ach uintile represents theco++on stoc in#est+ents o& +ore than 12,000 households.escripti#e statistics on the partition by port&olio si6e are presented in Table ;;;, Danel A. The lar(est port&olios ha#e a+ean be(innin( position +aret #alue o& H1=0, thes+allest port&olios a#era(e H1,=81. *+all port&olios ha#e

sli(htly hi(her +onthly turno#er 7.8 percent than lar(e port&olios 7. percent. As be&ore, "e esti+ate the para+eters o& the Fa+a-French three-&actor +odel, "here thedependent #ariable is the +onthly +ean (ross householde?cess return &or each uintile.1$ The coe&&icient esti+ates onthe +aret, si6e, and boo-to-+aret &actors re#eal that s+all port&olios tilt +ore hea#ily to"ard hi(h-beta, s+all, #alue

stocs than do lar(e port&olios.The (ross and net returns &or each uintile are presentedin Table ;;;, Danels B and '. Focusin( &irst on the (ross per&or+ance 7Danel B, "e &ind that s+all port&olios 7uintile1 earn hi(her a#era(e returns than lar(e port&olios 7uintile

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=, thou(h the di&&erence is not reliably di&&erent &ro+ 6ero.This di&&erence is liely attributable to the &act that s+all port&olios tilt +ore hea#ily to"ard s+all #alue stocs, "hich

per&or+ed "ell durin( our sa+ple period. The net per&or+ance results are presented in Danel '. The +aret-ad@usted return and 3ensenPs alpha are si+ilar to thosereported &or the &ull sa+ple &or each uintile. Thou(h the point esti+ates are consistently ne(ati#e, they are notreliably so. O& course, these ris-ad@ust+ents i(nore the &actthat in#estors are tiltin( to"ard s+all #alue stocs. ;n

contrast, the o"n-bench+ar abnor+al returns and theintercept tests &ro+ the Fa+a-French three-&actor +odelindicate si(ni&icant underper&or+ance, ran(in( &ro+ 1= to > basis points per +onth, in each o& the uintiles. ;n su+, a&tera reasonable accountin( &or the si6e and #alue tilts o& s+allin#estors, "e docu+ent that both s+all and lar(e port&oliosunderper&or+.

C. Cross8Sectional ariation inPerformance

e should e+phasi6e that the a((re(ate per&or+ance anda#era(e household per&or+ance, thou(h (er+ane andinterestin(, +as considerable cross-sectional #ariation in the

per&or+ance across households. For each household, "ecalculate the +ean +onthly +aret-ad@usted abnor+al return.e present the distribution o& these +eans in Table;!.20 'onsistent "ith the results presented in Table ;;, the+edian household earns a (ross +onthly +aret-ad@usted

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return o& 0.01 percent and a net return o& 0.1< percent.Thou(h


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yield di&&erent predictions about the (ains o& tradin(. Therational e?pectations +odel predicts that in#estors "ho trade+ore 7i.e., those "hose e?pected tradin( is (reater "ill ha#e

the sa+e e?pected utility as those "ho trade less. Theo#ercon&idence +odel predicts that in#estors "ho trade +ore"ill ha#e lo"er e?pected utility.Tale I. 'ross-*ectional istribution o& Dercenta(e Monthly )ross and 4et Maret-Ad@ustedGousehold %eturns

1. LLL indicates si(ni&icant di&&erence &ro+ =0 percent at the 1N le#el.

The sa+ple is account records &or ,


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"ith lo" turno#er, but there "ill be little di&&erence in the netris-ad@usted returns.To test these co+petin( +odels, "e partition our sa+ple o&

households into uintiles on the basis o& +ean +onthlyturno#er 7de&ined as the a#era(e o& purchase and saleturno#er. ach uintile represents the co++on stocin#est+ents o& +ore than 12,000 households. escripti#estatistics &or each o& the uintiles are presented in Table !,Danel A. The households "ith lo" turno#er a#era(e 0.1$ percent turno#er per +onth, those "ith hi(h turno#er a#era(e

21.


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+ore hea#ily to"ard hi(h-beta, s+all, (ro"th stocs,indicates that the t"o hi(h turno#er uintiles 7uintiles < and= underper&or+ by 2< and basis points per +onth.

Thou(h +ar(inally statistically si(ni&icant 7p-#alues o& 0.1


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%$t 0.20LLL 0.10LLL 0.1LL 0.1L 0.12

70.000 70.012 70.020 70.0= 70.1$=

S$Bt 0.22LLL 1.02LLL

70.000 70.000 70.000 70.000 70.000

Ad@usted #2 $.1 $ $2.2 $0.< 8>.

Danel B )ross A#era(e Gousehold Dercenta(e Monthly %eturn

%a" return 1.


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Fa+a-French intercept 0.02 0.1 0.=$

70.=2 70.> 0.08 0.1


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18.= percent 7&or uintile 2 to 18.> percent 7&or uintile 1.Go"e#er, there are dra+atic di&&erences in the net returnsacross the turno#er uintiles. An in#est+ent +i+icin( the

a#era(e household o& the hi(h turno#er uintile "ould ha#eearned a net annuali6ed +ean (eo+etric return o& 11.< percent, "hile an in#est+ent that +i+iced the lo" turno#eruintile "ould ha#e earned 18.= percent. These returns are(raphed in Fi(ure 1.

. Price 6omentum

*o+e authors ha#e identi&ied price +o+entu+ e&&ects instoc returnsXthat is, stocs that ha#e per&or+ed "ellrecently tend to earn hi(her returns than those that ha#e not7


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short those that ha#e per&or+ed poorly. e then esti+ateti+e-series re(ressions &or each o& the sa+ple partitionsdescribed in the +ain te?t. ;n all sa+ple partitions, the

esti+ated coe&&icient esti+ate on the 6ero-in#est+ent price-+o+entu+ port&olio is ne(ati#eK indi#iduals tend to tilt theirin#est+ents to"ard stocs that ha#e per&or+ed poorlyrecently.The net per&or+ance o& indi#idual in#estors in a((re(ate 7ona#era(e is 0.0= 70.00 percent per +onth &orthose "ho trade least 7uintile 1. Thus, "hen one controls&or their tendency to hold poorly per&or+in( stocs, thosein#estors "ho trade least acti#ely achie#e reasonable per&or+ance. More i+portant, ho"e#er, is the &indin( that

acti#e in#estors continue to underper&or+ less acti#ein#estors. The di&&erences in the intercepts re+ains lar(e andstatistically si(ni&icant 0.


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I. 1i=uidit#0 /ealancing0 and

Ta>86otivated Trading

To this point, "e ha#e &ocused on in&or+ation-+oti#ated#ersus o#ercon&idence-+oti#ated tradin(. The e+piricale#idence "e ha#e presented solidly &a#ors o#ercon&idence asthe +a@or +oti#ation &or tradin(, since tradin(una+bi(uously hurts in#estor per&or+anceK ho"e#er, thereare other +oti#ations &or tradin(, "hich "e consider in this

section.7. 1i=uidit#

;n#estors "ho &ace liuidity shocs o#er ti+e "ill trade as arational response to those shocs. Thus, liuidity shocs cane?plain so+e tradin( acti#ity. But, they see+ i+plausible asan e?planation o& the >= percent annual turno#er that "e

docu+ent &or the a#era(e indi#idual in#estor and belieco++on sense as an e?planation o& the +ore than 2=0 percent annual turno#er o& the households "ho trade +ost.;n#estors &acin( rapidly &luctuatin( liuidity needs can, in+ost cases, &ind less e?pensi#e +eans to &inance these thanrapid tradin( in and out o& stocs.

Moreo#er, the tradin( that results &ro+ liuidity shocs can be acco+plished at a +uch lo"er cost by in#estin( in +utual&unds than by in#estin( in indi#idual co++on stocs. Toillustrate this point, "e analy6e the returns on the !an(uard;nde? =00 +utual &und, a lar(e passi#e +utual &und that


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clai+s to +atch the per&or+ance o& the *tandard and DoorPs=00. ;n#estors can +o#e in and out o& this &und at no cost. ;ncontrast to the per&or+ance o& the a#era(e or a((re(ate

household, this inde? &und does not underper&or+ "henco+pared to any o& the standard per&or+ance bench+ars.urin( our sa+ple period, this &und earned an annuali6ed(eo+etric +ean return o& 1>.8 percent "hile the #alue-"ei(hted +aret inde? earned 1>.$ percent. The +aret-ad@usted return, the 'ADM intercept, and the Fa+a-Frenchintercept &or the !an(uard ;nde? =00 "ere 0.002, 0.00= percent annual turno#er that "e docu+ent &or the a#era(ehousehold belies co++on sense. ;n#estors can +ana(e the

ris co+position o& their port&olio at +uch lo"er cost bycare&ully selectin( a port&olio o& +utual &unds.

C. Ta>es


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The sin(le +ost co+pellin( reason &or in#estors to holdindi#idual co++on stocs in lieu o& +utual &unds is ta?es.;n#estors "ho hold stocs that ha#e lost #alue since their

purchase can reali6e those losses. These losses can be used toshelter (ains and thereby reduce the in#estorPs ta? liability.2

Ta?-loss sellin( cannot co+pletely e?plain the results that "edocu+ent here &or three reasons. First, it is i+plausible thatta?-+oti#ated tradin( "ould yield an annual turno#er rate o&>= percent. A si+ple e?a+ple illustrates this point 'onsideran in#estor "ho buys the #alue-"ei(hted +aret inde? on

3anuary 1 o& each year 1$$1 to 1$$. ;n ece+ber o& thea#era(e year, this in#estor "ould be able to sell 2< percent o& her port&olio &or a loss. O& course, this e?a+ple assu+es aholdin( period o& 12 +onths. The turno#er resultin( &ro+ta?-loss sellin( "ill decline as this holdin( period increases.

*econd, "e &ind hi(h turno#er and si(ni&icant

underper&or+ance in both ta?able and ta?-de&erred accounts.;& ta?-loss sellin( is the +a@or +oti#ation &or tradin( "e"ould e?pect to &ind little tradin( in ta?-de&erred accounts.On the other hand, i& o#ercon&idence is the +a@or +oti#ation&or tradin(, "e "ould e?pect to &ind, as "e do, acti#e tradin(and si(ni&icant underper&or+ance in both ta?able and ta?-de&erred accounts. e partition the accounts in our sa+ple

into ta?able and ta?-de&erred accounts 7i.e., ;ndi#idual%etire+ent Accounts and eo(h Accounts. ;n Table !;,Danel A, "e present descripti#e statistics &or the ta?able andta?-de&erred accounts. Turno#er in ta?-de&erred accounts ishi(h >. percent annually 7+onthly turno#er o& =.



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percent ti+es 12, thou(h not as hi(h as in ta?able accounts8$.< percent annually 7+onthly turno#er o& >.


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Danel A escripti#e *tatistics

4u+ber o& households =


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Ad@usted #2 $2. $2.2

Danel B )ross A#era(e Gousehold Dercenta(e Monthly %eturn

%a" return 1.$

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O"n-bench+ar abnor+al return 0.20LLL 0.1LLL

70.000 70.000

Maret-ad@usted return 0.10> 0.0 to 1$$ and that, relati#e to theiropportunities to do so, these in#estors are about one and one-hal& ti+es +ore liely to reali6e any (ain than any loss. They

do en(a(e in ta?-loss sellin( late in the year, but ece+ber isthe only +onth in "hich they reali6e losses at as &ast a rate asthey do (ains.Finally, "e should e+phasi6e that tradin( not associated "ithta?-loss sellin( "ill &urther hurt the a&ter-ta? returns o&

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indi#idual in#estors. 4ot only does this tradin( incur tradin(costs, "hen done in a ta?able account it also accelerates the pay+ent o& capital (ain ta?es that could be other"ise

de&erred.!. $amling

To "hat e?tent +ay a desire to (a+ble account &or thee?cessi#e tradin( "e obser#eY Many people appear to en@oy(a+blin(. *o+e buy lottery ticets. Others (a+ble atcasinos. e consider t"o distinct aspects o& (a+blin( ris-

seein( and entertain+ent. %is-seein( is "hen onede+onstrates a pre&erence &or outco+es "ith (reater #ariance but eual or lo"er e?pected return. ;n euity +arets thesi+plest "ay to increase #ariance "ithout increasin(e?pected return is to underdi#ersi&y. ?cessi#e tradin( has arelated, but decidedly di&&erent, e&&ectK it decreases e?pectedreturns "ithout decreasin( #ariance. Thus ris-seein( +ay

account &or underdi#ersi&ication 7thou(h underdi#ersi&icationcould also result &ro+ si+ple i(norance o& its bene&its, but itdoes not e?plain e?cessi#e tradin(.

A second aspect o& (a+blin( is the entertain+ent deri#ed&ro+ placin( and reali6in( bets. hen coupled "ith theo#ercon&ident belie& that these bets are e?pected-"ealth

enhancin(, it is easy to see that the entertain+ent utility o&(a+blin( "ill &uel (reater tradin(. There is also the possibility that people +ay trade &or entertain+ent "hile&ully reali6in( that each trade is +ore liely than not toreduce their personal &uture "ealth. 74ote that this is


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di&&erent &ro+ reali6in( that the trades o& others are "ealthreducin(. e &a#or the hypothesis that +ost in#estors tradee?cessi#ely because they are o#ercon&ident, or because they

are o#ercon&ident and they en@oy tradin(, o#er the hypothesisthat they trade purely &or entertain+ent and e?pect thereby tolo"er their "ealth. Many studies ha#e established that peopleare o#ercon&ident. e no" o& no study de+onstratin( thatordinary in#estors e?pect to lo"er their "ealth throu(htradin(.

;t is possible that so+e in#estors set aside a s+all portion o&their "ealth "ith "hich they trade &or entertain+ent, "hilein#estin( the +a@ority +ore prudently. ;& Ientertain+entaccountsJ are dri#in( our &indin(s, "e "ould e?pect turno#er and underper&or+ance to decline as the co++on stocs inthe accounts "e obser#e represent a lar(er proportion o& ahouseholdPs total "ealth. e are able to test this hypothesis

directly and &ind no support &or it. For appro?i+ately one-third o& our sa+ple, the households reported their net "orthat the ti+e they opened their accounts. e calculate the proportion o& net "orth in#ested at the discount broer as the be(innin( #alue o& a householdPs co++on stoc in#est+entsscaled by its sel&-reported net "orth.2= percentannually to our &ull sa+ple 7see Table ;. Further+ore, thesehouseholds earn (ross and net returns that are #ery si+ilar to



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the &ull sa+ple. The +onthly net return, o"n-bench+arabnor+al return, +aret-ad@usted return, 'ADM intercept,and Fa+a-French intercept &or these households are 1.28=,

0.1>, 0.1=, 0.221, and 0.28= percent, respecti#ely.Finally, it is "orth notin( that the ne(ati#e relation bet"eenturno#er and net returns that "e docu+ent &or indi#idualin#estors also e?ists in +utual &unds 7Carhart %&''3*. ;t isunliely that +utual &und +ana(ers buy and sell stocs &orthe pure @oys o& tradin( despite the &act that this tradin(lo"ers the e?pected returns o& their shareholders.2=

II. Conclusione analy6e the returns earned on co++on stoc in#est+ents by ,. e docu+ent that the(ross returns 7be&ore accountin( &or transaction costs earned by these households are uite ordinary, on a#era(e.

n&ortunately, the net returns 7a&ter accountin( &or the bid-as spread and co++issions paid by these in#estors earned by these households are poor. The a#era(e householdunderper&or+s a #alue-"ei(hted +aret inde? by about $ basis points per +onth 7or 1.1 percent annually. A&teraccountin( &or the &act that the a#era(e household tilts itsco++on stoc in#est+ents to"ard s+all #alue stocs "ith

hi(h +aret ris, the underper&or+ance a#era(es 1 basis points per +onth 7or .> percent annually. The a#era(ehousehold turns o#er appro?i+ately >= percent o& itsco++on stoc port&olio annually. The poor per&or+ance o&

http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-bib-0006http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-note-0031http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-bib-0006http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-note-0031


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about >0 percentK the a#era(e turno#er is about >= percent.The 4e" :or *toc ?chan(e reports that the annualturno#er o& stocs listed on the e?chan(e ho#ered around =0

percent durin( our sa+ple period. Mutual &unds a#era(e anannual turno#er o& >> percent 7Carhart %&''3*. e belie#ethat these hi(h le#els o& tradin( can be at least partlye?plained by a si+ple beha#ioral bias Deople areo#ercon&ident, and o#ercon&idence leads to too +uch tradin(.Based on rational a(ents &ree &ro+ such beha#ioral biases,the e&&icient +arets hypothesis has been central to both the

theory and practice o& in#est+ent +ana(e+ent. Thee&&iciency research posits that pri#ate in&or+ation is rare.Thus, acti#e in#est+ent strate(ies "ill not outper&or+ passi#e in#est+ent strate(ies. Both the theoretical ande+pirical "or on e&&iciency supportin( this #ie" ha#e led toa rise o& passi#e in#est+ent strate(ies that si+ply buy andhold di#ersi&ied port&olios 7Fama %&''&*.

Beha#ioral &inance +odels that incorporate in#estoro#ercon&idence 7e.(., "dean %&''(* pro#ide an e#enstron(er prediction Acti#e in#est+ent strate(ies "illunderper&or+ passi#e in#est+ent strate(ies. O#ercon&identin#estors "ill o#eresti+ate the #alue o& their pri#atein&or+ation, causin( the+ to trade too acti#ely and,conseuently, to earn belo"-a#era(e returns. 'onsistent "ith

these beha#ioral +odels o& in#estor o#ercon&idence, "e pro#ide e+pirical e#idence that households, "hich holdabout hal& o& .*. euities, trade too +uch, on a#era(e.Those "ho trade the +ost are hurt the +ost.

Appendix A. The Analysis of Trade Timing

http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-bib-0006http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-bib-0009http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-bib-0028http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-bib-0006http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-bib-0009http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-bib-0028


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In this appendix, we analyze the timing of purchases and sales within a month. Thetiming of trades within a month is ignored in our main analysis where we assume allpurchases and sales are made at month end.

Table AI. The Gross Abnormal Returns for Stocs !ought and Sold from the Trade "ate to the #nd of the $onth



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Danel ' Gouseholds Dartitioned by Turno#er

1 7o" 0.2 0.18< 0.2 0.08

2 1.> 0.1> 1.1< 0.08$

.0> 0.12 2.=> 0.0= 0.00

%onsistent with the results reported in Odean (1999), we document that the stocsin&estors buy subse'uently underperform the stocs they sell. In aggregate, weestimate that an exact accounting for the timing of purchases and sales would reducethe performance of indi&idual in&estors by more than two basis points per month (orapproximately ).*+ percent annually.-or each account with a beginningofmonth position statement in month t , we identify

all purchases in month t−1t/0 and sales in month t . -or both purchases and sales, we

calculate the compound return on the stoc from the day following the trade to the lastday of the month. -or purchases this return is excluded from our main results1 for salesthis return is included. 2ote that in our main results, we account for the intraday returnon the trade day in our estimate of the bidas spread.

Figure A1.• 3pen in figure &iewer

• "ownload 4owerpoint slide

Time line of returns calculations. The time of purchase (sale is t b (t s ). The close on the purchase

(sale day is tclb(tcls)tbcl(tscl. The close on the last day of the purchase (sale month is t 0 (t 5.

The results of our analysis are presented in Table AI. The second (fourth columns of

this table present aggregate purchase (sale turno&er calculated as the aggregate dollar &alue of purchases (sales di&ided by the aggregate dollar &alue of positions held. (Thisturno&er measure is slightly different from that used in the main text, where turno&er iscalculated based on maret &alues contained in position statements and is thus cappedat 0)) percent per month for each household. Abnormal returns are calculated forpurchases and sales by subtracting the compound return on the %RS426S#7A$#872asda' &alueweighted index. The tradeweighted mean abnormalreturns are presented in columns 5 (for purchases and 9 (for sales of Table AI. In

http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-bib-0029http://onlinelibrary.wiley.com/enhanced/figures/doi/10.1111/0022-1082.00226#figure-viewer-jofi226-fig-0002http://api.onlinelibrary.wiley.com/asset/v1/doi/10.1111%2F0022-1082.00226/powerpoint/image_n%2Fjofi226-fig-0002.png?l=j6%2BNsqLlmq%2F%2BYjUiKTzcPTyXY4c3y%2Bwz%2BdpCaGRUFvOygPhB8NeLmArjb3aYbZnWpl%2BdwAZ5q8nW%0A%2FAquLbkztA%3D%3D&s=%223e65c3219b1643d7bdc9124d601f39f6%22&a=wolhttp://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-0007http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-0007http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-0007http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-bib-0029http://onlinelibrary.wiley.com/enhanced/figures/doi/10.1111/0022-1082.00226#figure-viewer-jofi226-fig-0002http://api.onlinelibrary.wiley.com/asset/v1/doi/10.1111%2F0022-1082.00226/powerpoint/image_n%2Fjofi226-fig-0002.png?l=j6%2BNsqLlmq%2F%2BYjUiKTzcPTyXY4c3y%2Bwz%2BdpCaGRUFvOygPhB8NeLmArjb3aYbZnWpl%2BdwAZ5q8nW%0A%2FAquLbkztA%3D%3D&s=%223e65c3219b1643d7bdc9124d601f39f6%22&a=wolhttp://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-0007http://onlinelibrary.wiley.com/doi/10.1111/0022-1082.00226/full#jofi226-tbl-0007


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aggregate (4anel A, from the day following the trade to the end of the month, thestocs that in&estors buy underperform the &alueweighted maret index by :; basispoints, and those they sell outperform the index by two basis points. !ased on theseabnormal returns and our estimates of aggregate turno&er, we calculate that the resultswe present in the main text o&erestimate the performance of indi&idual in&estors by *.:*

basis points per month.


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Danel B Gouseholds Dartitioned by Be(innin( Dosition !alue

1 7*+all 1>, 0.$0< 1.$ 2.082 0.2,1> 1.>=> 0.

< 20,2== 1. 0.=1 1.

= 7ar(e 28,8> 1.= 0.=2 0.8

Danel ' Gouseholds Dartitioned by Turno#er

1 7o" 10,8 0.00 0.02 0.00

2 12,8> .00 0.200 0.02

11,88 1.88 0.

= 7Gi(h 2,>02 1.=


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$. $A &i&th alternati#e +easure o& ris-ad@usted returns is the *harpe ratio, the +ean e?cess return di#ided by itsstandard de#iation. The a#era(e *harpe ratio &or the (ross 7net return o& the a#era(e household in our sa+pleis 0.1>$ 70.18/2.8880 . e do not report *harpe ratios &or +ost partitions o& the data

because "e do not obser#e the entire port&olios o& these households. nobser#ed assets such as euities atother broera(e &ir+s and +utual &und holdin(s are unliely to (reatly chan(e a#era(e obser#ed port&olioreturns, but they are liely to reduce a#era(e obser#ed #olatility. Thus "e tend to underesti+ate the total

port&olio *harpe ratios o& in#estors "ith si(ni&icant unobser#ed assets.10. 10

hen calculatin( this bench+ar, "e be(in the year on February 1. e do so because our &irst +onthly position state+ents are &ro+ the +onth end o& 3anuary 1$$1. ;& the stocs held by a household at the be(innin(o& the year are +issin( '%*D returns data durin( the year, "e assu+e that stoc is in#ested in the re+ainder o&the householdPs port&olio.

11. 11The return on Treasury bills is &ro+ Stocks) Bonds) Bills) and Inflation) *++, -earbook , ;bbotson Associates,'hica(o, ;ll.

12. 12The construction o& these port&olios is discussed in detail in Fama and French %&''-*. e than ennethFrench &or pro#idin( us "ith these data.

1. 11#on0 4arer0 and Tsai %&'''* docu+ent that intercept tests usin( the three-&actor +odel are "ell speci&ied inrando+ sa+ples and sa+ples o& lar(e or s+all &ir+s. Thus, the Fa+a-French intercept tests e+ployed hereaccount "ell &or the s+all stoc tilt o& indi#idual in#estors.

1


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e o+it &ro+ this analysis accounts that held co++on stocs &or &e"er than 12 +onths durin( our >2-+onthsa+ple period.

21. 21%ather than increasin( their (ross returns, acti#e traders could alternati#ely achie#e the sa+e e?pected utilityas less acti#e traders by lo"erin( their #olatility throu(h tradin(. e &ind no e#idence o& this ho"e#er. Fore?a+ple, the a#era(e 7net *harpe ratio o& the uintile that trades +ost acti#ely 70.0$2 is one-hal& that o& theuintile that trades least acti#ely 70.180. Thou(h these *harpe ratios do not consider in#estorsP total port&olioso& assets 7see &ootnote $, they indicate that acti#e traders do not ha#e hi(her #olatility ad@usted returns "ithinthe obser#ed euity port&olios.

22. 22The construction o& the 6ero-in#est+ent price-+o+entu+ port&olio is described in Carhart %&''3*. e thanMar 'arhart &or pro#idin( us "ith the returns data.

2. 2Thou(h losses on +utual &unds can also be used to reduce an in#estorPs ta? liability, the probability o& ha#in( aloss on a +utual &und is less than the probability o& obser#in( at least one losin( in#est+ent in a "ell-di#ersi&ied port&olio o& co++on stocs.

2

common stock 3

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