Individual Investor Activity and Performance

Research Retrieved: March 2017
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Review of Financial Studies, 30(3), 866-899.

Issue

Assets in defined contribution (DC) pension plans are increasingly becoming the main source of retirement income. Consequently, individuals have more responsibility to invest themselves. Several studies have shown that some individual investors are overconfident and trade too often (see, for example Barber & Odean, 1999, 2000) – these studies, however, use discount brokerage firm data. Does this result also hold in a DC context? How does portfolio performance vary between active and inactive traders? Do financial advisers help individuals to earn money or do the costs eat up the benefits?

Key Findings

Dahlquist et al. (2017) find that most individual investors in the Swedish Premium Pension System do not trade (93.5%). Active traders do outperform inactive traders significantly. The outperformance is not due to the fact that active traders hold riskier portfolios, but rather due to timing ability. Active investors are more likely to invest in past good performers when they change their portfolio. They cash in the high returns in the first month after the portfolio change. The researchers define coordinated traders as traders who follow the advice of financial advisers. 80% of all fund changes are executed by these investors. However, the gross outperformance vanishes when average adviser fees are considered. Lastly, it is shown that active trading in mutual funds is detrimental to all investors: the costs of redemption are borne by the mutual fund, thus by all investors who have not sold the mutual fund.

 

Practical Relevance

The paper shows that when investors are “left alone”, most DC pension plan investors do not trade in Sweden. The few active traders do outperform the inactive traders, but also put additional costs on all investors. This leads to the question whether the Swedish pension design should be improved. As the authors put it:” Should fees be charged that either discourage costly short-term investments or compensate the fund for its transaction costs?” In Sweden, there are no such fees, the SEC in the US recommend them. Furthermore, the added value of financial advisers is highly questioned. The advice only leads to gross outperformance, not to net-of-fees outperformance.