TAILIEUCHUNG - Trading Is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors

Our notion of what triggers a boom-bust cycle is very stylized: the signal occurs on a particular date and people learn that it is exactly false on another particular date. In more realistic scenarios, people form expectations based on an accumulation of various signals. If people’s expectations are in fact overoptimistic, they come to this realization only slowly and over time. Although the trigger of the boom-bust cycle in our analysis is in some ways simplistic, it has the advantage of allowing us to highlight a result that we think is likely to survive in more realistic settings | THE JOURNAL OF FINANCE VOL. LV NO. 2 APRIL 2000 Trading Is Hazardous to Your Wealth The Common Stock Investment Performance of Individual Investors BRAD M. BARBER and TERRANCE ODEAN ABSTRACT 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 percent while the market returns percent. The average household earns an annual return of percent tilts its common stock investment toward high-beta small value stocks and turns over 75 percent of its portfolio annually. Overconf idence can explain high trading levels and the resulting poor performance of individual investors. Our central message is that trading is hazardous to your wealth. The investor s chief problem and even his worst enemy is likely to be himself. Benjamin Graham In 1996 approximately 47 percent of equity investments in the United States were held directly by households 23 percent by pension funds and 14 percent by mutual funds Securities Industry Fact Book 1997 . Financial economists have extensively analyzed the return performance of equities managed by mutual funds. There is also a fair amount of research on the performance of equities managed by pension funds. Unfortunately there is little research on the return performance of equities held directly by households despite their large ownership of equities. Graduate School of Management University of California Davis. We are grateful to the discount brokerage firm that provided us with the data for this study. We appreciate the comments of Christopher Barry George Bittlingmayer Eugene Fama Ken French Laurie Krig-man Bing Liang John Nofsinger Srinivasan Rangan Mark Rubinstein René Stulz the editor Avanidhar Subrahmanyam Kent Womack Jason Zweig two anonymous reviewers seminar participants at the American Finance Association Meetings New York 1999 the 9th .

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