The Behavior of Individual Investors

TLDR: In this paper, the authors provide an overview of research on the stock trading behavior of individual investors and find that individual investors underperform standard benchmarks (e.g., a low-cost index fund), sell winning investments while holding losing investments (the “disposition effect”), are heavily influenced by limited attention and past return performance in their purchase decisions, engage in naive reinforcement learning by repeating past behaviors that coincided with pleasure while avoiding past behaviours that generated pain, and tend to hold undiversified stock portfolios.

Abstract: We provide an overview of research on the stock trading behavior of individual investors. This research documents that individual investors (1) underperform standard benchmarks (e.g. a low-cost index fund), (2) sell winning investments while holding losing investments (the “disposition effect”), (3) are heavily influenced by limited attention and past return performance in their purchase decisions, (4) engage in naive reinforcement learning by repeating past behaviors that coincided with pleasure while avoiding past behaviors that generated pain, and (5) tend to hold undiversified stock portfolios. These behaviors deleteriously affect the financial well being of individual investors.