Three scholars examine the portfolios and trades of over 20 thousand investors in mutual funds and stocks. They find that investors can usually be grouped into five categories. Which one describes you?
The person is young, poor, unsophisticated, and has little investment experience.
Trading tends to see undiversified plunges into few stocks with characteristics they like, often with lottery like payoffs. They like high beta stocks, small companies, value stocks, and to trade against momentum.
Ramifications: high level of behavioral biases, high risk stocks, low portfolio diversification, poor returns
The person is a professional, has high income, and long investment experience.
The portfolio is well diversified and they are likely to also have a tax-deferred account, like an IRA. The portfolio is tilted to large companies, some with value orientation and some with momentum. Trading shows awareness of tax ramifications, like tax loss selling in December. Periodically conducts short selling.
Ramifications: low level of behavioral biases, diversified portfolio, takes high market risks, high returns
The person is usually single, male, working, and has only a short period of investment experience.
The portfolio is poorly diversified and has stocks with lottery characteristics. Overconfident investors trade frequently and are more likely to use options.
Ramifications: overconfident in abilities, under-diversified portfolio, trades too much, poor returns
The person is young, poor, and has little investment experience.
This person’s attention is mostly on the performance of each individual stock (narrow framing) and less on portfolio aspects. As such, they are more likely to sell winners too soon and hold losers too long (disposition effect). The narrow focus does allow them to show some tax awareness, like tax loss selling in December, but less tax awareness in holding losers.
Ramifications: poorly diversified portfolio, higher portfolio risk, poor returns
The person is older, retired, and has a lot of investment experience.
The portfolio is well diversified, but more conservative as it has lower market, value, and momentum risks. Trading exhibits an understanding of tax timing.
Ramifications: low level of behavioral biases, diversified portfolio, takes low market risks, good returns
Source: Warren Bailey, Alok Kumar, and David Ng, “Behavioral biases of mutual fund investors,” Journal of Financial Economics, 2011, vol. 102, pp. 1-27.