Why Do Individual Investors Underperform?

The bulk of research in market economics is built on this notion of this rational investor, that tries to maximize their investment wealth and minimize losses, but our research actually shows the opposite.

Modern financial theory, at least until probably 15 – 20 years ago was dominated about the idea that people are very rational when it comes to money and as I think all of us realize, that is not always the case. I've done research and I've worked a lot with my colleagues where we look at the actual trading records for individual investors, we've looked at records for hundreds of thousands, at this point millions of investors and we've found a lot of pretty predictable patterns.

Not all investors, but especially self-directed investors trade excessively and one very strong finding that we have is that the more actively investors trade on average, the less they earn. In fact, an interesting twist, we looked at the difference in how men and women invested and our hypothesis was that men would be more confident than women and as a result trade more, and this trading would hurt their returns. We found that men traded much more actively than women, one and a half times as actively as women and that this act of trading really cut into their returns.

The Taiwanese 14-Year Case Study

What we found was not actually that surprising. Most day traders lose money. We looked at Taiwan because we got this phenomenal data set, we know every trade made by every investor in Taiwan over this 14-year period and Taiwan has a lot of day traders. 98% - 99% of them are tending to lose money, at any given 6-month period, maybe 20% will come out ahead but most of those are just lucky. Persistently there are a few that actually make money predictably but most of them are not doing so.

So the question is, does that 14-year study in Taiwan cross cultures and does it apply to US investors? Here are the biggest issues. In Taiwan, there's a transaction tax that makes it hard to be a day trader and so that's relevant. But in the US, investors face more of what economists call asymmetric information risk and really what that means is, if you're an individual investor and you place an order to buy or sell a stock in the US, it's very, very likely the person on the other side of that trade is an institutional investor, an investor that has more resources than you, more experience, more data, is working with a team, and on average, you're just not going to come out ahead.

You may win a few, but it's like deciding you're going to go one on one a silver back gorilla. How does that apply to the extremes in the cryptocurrency markets and how much does that impact the psychology of investors in making them prone to making decisions that are bad for themselves? So volatility brings up emotions, and emotions get people in trouble. In both directions, we found that in the late 90s, 1998, 1999, there was, dot-com stocks that were going through the roof, people who had never traded speculatively started to do so. I had a friend who was a retired school teacher in Canada that sold all of her Canadian mutual funds to buy US high-tech stocks and she did it right before the crash.

So good markets can get you in trouble, and then the other side can get you in trouble, that a lot of people panic during cryptocurrency crises and sold all of their digital currencies and went to cash and when the market recovered, they missed out on the recovery. In general, investors are better off taking a buy and hold approach, not trying to outsmart the market, but just ride it out.

Ride it out. Don't put everything in when the market goes well, and don't panic when the market goes badly. Just take a long ride. CoinJolt makes investing in Bitcoin both simple and easy. Our built-in custodian services mean all digital assets are safe and secured with insurance on all your investments. 

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