Do individual investors learn from their mistakes?

Abstract

Based on recent empirical evidence which suggests that as investors gain experience, their investment performance improves, we hypothesize that the specific mechanism through which experience translates into better investment returns is closely related to learning from investment mistakes. To test our hypotheses, we use an administrative dataset which covers the trading history of 19,487 individual investors. Our results show that underdiversification and the disposition effect do not decline as investors gain experience. However, we find that experience correlates with less portfolio turnover. We conclude that compared to other investment mistakes, it is relatively easy for individuals to identify and avoid costs related to excessive trading activity. When correlating experience with portfolio returns, we find that as investors gain experience, their portfolio returns improve. A comparison of returns before and after accounting for transaction costs reveals that this effect is related to learning from overtrading.

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Notes

  1. 1.

    Campbell et al. (2015) use an Indian dataset for similar reasons.

  2. 2.

    For a more comprehensive and detailed review and discussion of behavioral biases among investors, see, for example, Barberis and Thaler (2003) or Subrahmanyam (2007).

  3. 3.

    In this chapter we focus on 19,487 individual investors that opened their account during the observed time period, which is a subset of the overall dataset that includes 69,734 investors.

  4. 4.

    When comparing our sample with the German investor population, we focus on the year 2000, because this is when the largest fraction of investors appeared in the sample for the first time.

  5. 5.

    Statman et al. (2006) document that market-wide turnover is strongly positively related to lagged returns for many months.

  6. 6.

    We use a remaining maturity of one year because this maturity is the closest to the average holding period of securities in the sample.

  7. 7.

    By ‘active’ we mean trades that are actively triggered by the investor, which excludes savings plan trades.

  8. 8.

    Note that in Table 3 the number of observations and that of unique investors included in the regression is slightly lower than in Table 2. For an investor-year observation to be included in the regression, we require the given investor to have been a customer of the bank for at least three months. If, for example, an investor started trading in November, then this investor-year observation is not included in the regression as there are only two months of portfolio turnover data available.

  9. 9.

    We define “transaction fees” as all costs related to executing a buy or sell order, such as fixed and variable commissions, over-the-counter transaction fees, phone or broker-assisted markups, foreign exchange fees, etc. In contrast to Barber and Odean (2000), our measure for “transaction fees” does not, however, include costs related to the bid-asks spread and market impact of a transaction.

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Correspondence to Maximilian Koestner.

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Koestner, M., Loos, B., Meyer, S. et al. Do individual investors learn from their mistakes?. J Bus Econ 87, 669–703 (2017). https://doi.org/10.1007/s11573-017-0855-7

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Keywords

  • Investor learning
  • Investment mistakes
  • Household Finance

JEL Classification

  • D03
  • D14
  • G11