A recent study about Norwegian traders and investors sheds some light on the returns (or lack of) based on diversification, age, wealth, and risk appetite. The study is called What Do the Portfolios of Individual Investors Reveal About the Cross-Section of Equity Returns?
It turns out that wealth and age are major contributors to returns, perhaps not surprisingly:
The tilts of investor portfolios toward the new factors are driven by wealth, indebtedness, macroeconomic exposure, age, gender, education, and investment experience.
What determines stock market performance among investors?
Over the last year, many newcomers have entered the stock market, most of them being young and naive without much knowledge about financial markets. For the first time ever, Norway has registered more than 500 000 different personal shareholders, 130 000 more since the start of Covid-19. 40% of the new investors are under 30 years of age. Much worse, though, is that 40% of the new shareholders only own just one stock!
Many might have made nice gains in popular stocks like Gamestop, Tesla, Kahoot, and NEL. But how are they likely to perform over the long term?
What Do Individual Investors’ Portfolios Reveal About the Cross-Section of Equity Returns?
This is the not-so-appealing name of the study by four teachers and professors: Betermier, Calvet, Knüpfer, and Kvaerner. These four researchers studied investors on Oslo Stock Exchange from 1997 to 2018. What did the study reveal?
“Old” investors make the most money
The best returns are made by those who are “old”. Mature and experienced owners, over time accomplish much better returns than young and inexperienced investors:
The graph above, copied from the study, shows that mature investors with high wealth manage to beat the market.
Young and inexperienced investors take huge risks
The young and inexperienced investors tend to focus on just a few companies and most in companies that have an uncertain business model. This leads to underperformance:
Investors lose their shirt in bear markets
Most inexperienced investors lose big time in a bear market. Because they are undiversified and invest in companies with mostly “unproven” business models, they take a big hit when the markets turn south. Many lose all their assets.
This is yet another argument for putting your assets in a passive or active fund. Investing is no rocket science. The easier you do it, the more likely you will get good results. Investing in a few companies with unproven business models is certainly not the way to go.
Diversification is a necessity
A few years back, the Norwegian brokerage Pareto Securities wrote a blog post (in Norwegian – hvordan tjene mer på aksjer) about how retail investors take on unnecessary risk by investing in just a few inherently risky stocks.
The ecology of markets
In The Education of A Speculator, Victor Niederhoffer wrote that the main purpose of new and inexperienced speculators is to provide food and prey for the speculators further up in the food chain. The study by Betermier, Calvet, Knüpfer, and Kvaerner very much confirms Niederhoffer’s ideas.
Conclusion: How do you start learning the stock market?
Another study result was that wealth is a major factor in predicting future returns. If you come from a family where your mum or dad owns shares, you are more likely to get good returns.
If you’re the first one in your family to invest in the stock market, you simply don’t have the knowledge to do it properly.
How do you start investing?
Do it the old and boring way: mutual funds.
Disclosure: We are not a financial advisors. Please do your own due diligence and investment research or consult a financial professional. All articles are our opinion – they are not suggestions to buy or sell any securities.
