Trading Is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors
Abstract (Via Journal Of Finance)
Individual investors who hold common stocks directly pay a tremendous performance penalty for active trading. Of 66,465 households with accounts at a large discount broker during 1991 to 1996, those that trade most earn an annual return of 11.4 percent, while the market returns 17.9 percent. The average household earns an annual return of 16.4 percent, tilts its common stock investment toward high-beta, small, value stocks, and turns over 75 percent of its portfolio annually. Overconfidence can explain high trading levels and the resulting poor performance of individual investors. Our central message is that trading is hazardous to your wealth.
Excerpt (Via Journal Of Finance)
We also document that, overall, the households we analyze significantly underperform relevant benchmarks, after a reasonable accounting for transaction costs. These households earn gross returns ~before accounting for transaction costs! that are close to those earned by an investment in a valueweighted index of NYSE0AMEX0Nasdaq stocks. During our sample period, an investment in a value-weighted market index earns an annualized geometric mean return of 17.9 percent, the average household earns a gross return of 18.7 percent, and in aggregate households earn a gross return of 18.2 percent. In contrast, the net performance ~after accounting for the bidask spread and commissions! of these households is below par, with the average household earning 16.4 percent and in aggregate households earning 16.7 percent. The empirical tests supporting these conclusions come from abnormal return calculations that allow each household to self-select its own investment style and from time-series regressions that employ either the Capital Asset Pricing Model ~CAPM! or the three-factor model developed by Fama and French ~1993! as our benchmark.
Our descriptive analysis provides several additional conclusions that are noteworthy:
1. Households trade common stocks frequently. The average household turns over more than 75 percent of its common stock portfolio annually.
2. Trading costs are high. The average round-trip trade in excess of $1,000 costs three percent in commissions and one percent in bid-ask spread.
3. Households tilt their investments toward small, high-beta stocks. There is a less obvious tilt toward value ~high book-to-market! stocks.