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Expert Analysis and Commentary

Larry Swedroe: Retail Investors Behaving Badly

Larry Swedroe Oct 27, 2014



Be sure to also take a look Under the Hood of the 10 Biggest Mutual Funds.


Understanding Individual Investors


  • Do retail investors herd into and out of certain industries?
  • How does retail investor industry demand impact stock prices?
  • To what extent is the poor performance of retail investor trading driven by their industry-wide investment decisions?

The following is a summary of their findings.


Do Retail Investors Herd?



Does Retail Investor Demand Impact Prices and Returns?


Be sure to also ready about the 7 Biggest Mistakes to Avoid When Investing in Mutual Funds.

The correlation between retail investor industry demand in the current week and retail investor industry demand in the prior week is more than 60 percent, and it is statistically significant. The correlation gradually declines over time.

The retail investor industry proportion of stocks bought over the prior quarter, six months, or year negatively forecast industry returns over the subsequent quarter, six months or year.

A portfolio that went short in the value-weighted quintile of industries most heavily bought over the prior quarter and long in the value-weighted quintile of industries most heavily sold in that quarter would earn an average abnormal return of 41 basis points per month over the subsequent quarter. The results are statistically significant at the 1 percent level, even after adjusting for the Fama-French factors. Results are similar for six-month and one-year horizons.


Is Their Poor Performance Driven by Industry-wide Investment Decisions?


While the authors confirmed prior research demonstrating that individual investors do exhibit perverse stock selection skills (the stocks they buy go on to underperform and the stocks they sell go on to outperform) they additionally found that industry selection is responsible for more than 60 percent of the previously documented poor performance. They write, “industry-wide sentiment has an effect on asset prices that is distinct from firm-specific sentiment.”

Another interesting finding was that retail investors tend to be firm-level contrarians over short horizons, but firm-level momentum traders over longer horizons. Unfortunately, momentum is a short-term phenomenon, and over the long-term we tend to see mean reversion.

Among the 77 mistakes covered in my book, “Investment Mistakes Even Smart People Make and How to Avoid Them,” is that of “recency.” Recency is the tendency to give too much weight to recent experience, buying what has done well and selling what has done poorly. Another mistake I cover is the tendency to be influenced by the herd mentality.

See also the 10 Biggest Mutual Fund Investing Myths Debunked.


The Bottom Line



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