Behavioral Gaps Between Hypothetical Investment Returns and Actual Investor Returns

Abstract

Individual investors behave badly. “[I]nvestors with strong behavioral biases or lack of attention” to meaningful financial news are more likely to forgo equity ownership or to participate in capital markets “for the wrong reasons.”¹ Individual investors, often the product of that lethal combination of ignorance and bias, “trade … frequently, tend to time their buys and sells badly, and prefer high expense [mutual] funds and active funds rather than index funds.”² Behavioral biases cost investors. Narrow framing extracts a 2.16 % premium from the most heavily affected quintile of individual investors relative to the least affected quintile.³ The disposition effect costs the worst quintile 0.89 % in annual returns relative to best quintile.⁴