Do individual investors learn from their mistakes?

Maximilian Koestner1, Steffen Meyer2, and Andreas Hackethal3

This version: August 2, 2012

Abstract: Based on recent empirical evidence which suggests that as investors gain experience, their investment performance improves, we hypothesize that the specific mechanism through which experience translates to better investment returns is closely related to learning from investment mistakes. To test our hypotheses, we use an administrative dataset which covers the trading history of 19,487 individual investors. Our results show that underdiversification and the disposition effect do not decline as investors gain experience. However, we find that experience correlates with less portfolio turnover, suggesting that investors learn from overconfidence. We conclude that compared to other investment mistakes, it is relatively easy for individuals to identify and avoid costs related to excessive trading activity. When correlating experience with portfolio returns, we find that as investors gain experience, their portfolio returns improve. A comparison of returns before and after accounting for transaction costs reveals that this effect is indeed related to learning from overconfidence.

JEL classification: D03, D14, G11 Keywords: Investor Learning, Investment Mistakes, Household Finance

Maximilian Koestner (koestner@fas.harvard.edu), Retail Banking Competence Center - Goethe University Frankfurt, House of Finance, Grneburgplatz 1, 60323 Frankfurt am Main, Germany. Phone: + 49 69 798 33675 2 Steffen Meyer (meyer@finance.uni-frankfurt.de), Retail Banking Competence Center - Goethe University Frankfurt, House of Finance, Grneburgplatz 1, 60323 Frankfurt am Main, Germany. Phone: + 49 69 798 33675 3 Andreas Hackethal (hackethal@gbs.uni-frankfurt.de), Chair of Finance, Goethe University Frankfurt, House of Finance, Grneburgplatz 1, 60323 Frankfurt am Main, Germany. Phone: + 49 69 798 33700

Electronic copy available at: http://ssrn.com/abstract=2122652

Do individual investors learn from their mistakes?

This version: March 5, 2012

Abstract: Based on recent empirical evidence which suggests that as investors gain experience, their investment performance improves, we hypothesize that the specific mechanism through which experience translates to better investment returns is closely related to learning from investment mistakes. To test our hypotheses, we use an administrative dataset which covers the trading history of 19,487 individual investors. Our results show that underdiversification and the disposition effect do not decline as investors gain experience. However, we find that experience correlates with less portfolio turnover, suggesting that investors learn from overconfidence. We conclude that compared to other investment mistakes, it is relatively easy for individuals to identify and avoid costs related to excessive trading activity. When correlating experience with portfolio returns, we find that as investors gain experience, their portfolio returns improve. A comparison of returns before and after accounting for transaction costs reveals that this effect is indeed related to learning from overconfidence.

JEL classification: D03, D14, G11 Keywords: Investor Learning, Investment Mistakes, Household Finance

Electronic copy available at: http://ssrn.com/abstract=2122652

Introduction
Since the formal beginnings of behavioral finance in the 1980s, numerous empirical studies have documented behavioral biases that lead to costly investment mistakes. In aggregate, investment mistakes result in significant underperformance of individual investors not just compared to institutional investors, but also compared to the overall market. Empirical studies suggest that the magnitude of negative abnormal returns ranges from 0.7% (French (2008)) to 3.7% per year (Barber and Odean (2000)). Barber et al. (2009) estimate that annual losses of Taiwanese individual investors aggregate to an amount equivalent to 2.2% of Taiwans gross domestic product. While it is well documented that the average investor underperforms the market, there is also evidence that some individual investors persistently outperform their peers. Coval, Hirshleifer, and Shumway (2005) find that a few highly-skilled investors persistently generate abnormal returns. Barber and Odean (2000) present evidence that the excessive trading of overconfident investors leads to poor investment performance, while individual investors with a low portfolio turnover achieve returns close to the market. Dhar and Zhu (2006) document that the disposition effect, the tendency to sell winning stocks too quickly and hold on to stocks that have lost value, is weaker among individuals considered financially literate. If some individual investors persistently achieve better returns than their peers, then the question arises where this skill originates from. Recent studies by Nicolosi, Peng, and Zhu (2009) and Seru, Schumway, and Stoffman (2010) suggest that learning plays a significant role in explaining the heterogeneity in investment performance. They provide evidence that as investors gain experience, their investment performance improves. We hypothesize that the specific mechanism through which experience translates into better investment performance is closely related to learning from investment mistakes. Studies in consumer markets have documented a range of occasions when individuals learn from their mistakes, such as in the context of credit card add-on fees (Agarwal et al. (2008)) and penalty fees for late returns of rental videos (Fishman and Pope (2006)). If poor investment performance is caused by various investment mistakes and if investors achieve higher investment returns as they gain more experience, then we should find that individual investors are less prone to investment mistakes as they gain investment experience. To test our hypotheses, we use an administrative dataset which covers the complete trading history of 19,487 German retail investors over a period of eight years. Considering that we only look at investors who started trading during the observed period, the sample appears to be a reasonable representation of the average private investor in Germany. We exploit the datasets panel structure to explore the relationship of three well documented investment mistakes underdiversification, overconfidence, and the disposition effect with investment experience. We opt for these investment mistakes not just because they rank among the most cited investment mistakes in finance literature, but also because a 1

significant negative effect on investment performance has been documented for each of the three investment mistakes (e.g., Goetzmann and Kumar (2008), Barber and Odean (2000), Odean (1998a)). The results show that underdiversification and the disposition effect do not decline as investors gain experience. Nevertheless, we find evidence that gains in experience are associated with less portfolio turnover, suggesting that investors learn from excessive trading which is associated with overconfidence. We find that a gain in experience equivalent to 100 additional trades is associated with a decline in monthly portfolio turnover of 0.8 percentage points, which is a considerable reduction considering that the average investor in the sample has an active portfolio turnover of 16.2% per month. Our findings are robust to the inclusion of various control variables in the regression specification, including investor and year fixed effects, measures for changes in the market environment and investment style, as well as various robustness checks using different subsamples. We conclude that compared to underdiversification and the disposition effect, it is relatively easy for individual investors to identify excessive trading activity, understand the nature and resulting costs of the mistake, and avoid it in the future. We are furthermore able to show that the findings of previous studies, which document that experience is related to higher short-term returns on purchased stocks as well as better trade quality, do translate into higher portfolio returns. When correlating investment experience with portfolio returns, we find strong evidence that experience leads to higher raw portfolio returns on an annual basis. The relationship of experience and risk-adjusted portfolio returns is also positive, but less clear cut. A comparison of portfolio returns before and after accounting for transaction costs reveals that the increase in portfolio returns we observe is indeed related to learning from overconfidence: When using returns including transaction costs, we document a strong correlation with investment experience. When using returns that ignore transaction costs, the relationship is considerably weaker. The remainder of the chapter is organized as follows. Section 2 discusses related literature and derives three testable hypotheses regarding investor learning. Section 3 summarizes the data used with a particular focus on the representativeness of the sample. Section 4 outlines the way we measure investment mistakes, portfolio returns, and investment experience. Additionally, the empirical model is discussed. Structured along three specific investment mistakes, Section 5 presents and elaborates the results. Section 6 presents several robustness checks and Section 7 summarizes our findings and concludes the chapter.

1. Related Literature and Hypotheses

A growing body of literature documents behavioral biases that lead to costly investment mistakes among individual investors. Individual investors have been shown to systematically overreact to unexpected and dramatic news events (e.g., De Bondt and Thaler (1985)), to suffer from a status quo bias in financial decision making (e.g., Samuelson and Zeckhauser (1988)), to hold investment portfolios that are underdiversified (e.g., French and Poterba (1991), Grinblatt and Keloharju (2001a)), to 2

suffer from overconfidence ( e.g., Camerer and Lovallo (1999)) leading to excessive trading volume in financial markets (e.g., Odean (1999)), to neglect background risks (e.g., Heaton and Lucas (2000)) such as holding their employers stock (e.g., Gerhardt (2008)), to engage in attention-based trading leading to herding behavior and investment decisions that are suboptimal (e.g., Kumar and Lee (2006)), and to suffer from disposition effects (e.g., Shefrin and Statman (1985)) that makes them hold losing investments too long and sell winning investments too early (e.g., Odean (1998a).4 In light of the variety of circumstances when the actual investment decisions of individual investors diverge from what orthodox finance theory describes as choices that maximize welfare (Campbell (2006)), it is not surprising that empirical studies have shown that the average household investor underperforms the market. Using a large dataset provided by a US discount brokerage firm, Barber and Odean (2000) find that the average household underperforms the market by 1.1% annually. When using the Fama-French three factor model to estimate returns, this underperformance increases to 3.7% annually. Similarly, French (2008) concludes that a typical investor in the US could increase portfolio returns by 0.7% annually by holding the market portfolio. Barber et al. (2009) come to a similar conclusion using the trading history of all investors in Taiwan. They estimate that losses of individual investors aggregate to an amount equivalent to 2.2% of Taiwans gross domestic product. While it is well documented that the average investor underperforms the market, there is also evidence that some individual investors persistently outperform their peers. Coval, Hirshleifer, and Shumway (2005) find strong persistence in the investment performance of individual investors. They conclude that few highly-skilled investors are able to systematically exploit market inefficiencies and thereby generate abnormal returns. Along the same line of research, Ivkovic, Sialm, and Weisbenner (2008), as well as Goetzmann and Kumar (2008) find that a small subset of individual investors deliberately underdiversifies and achieves abnormal returns because of superior stock-picking abilities. However, most investors persistently underdiversify, which results in significant economic costs. Barber and Odean (2000) present evidence that the excessive trading of overconfident investors leads to poor investment performance, while individual investors with a low portfolio turnover achieve returns close to the market. Dhar and Zhu (2006) document that the disposition effect is weaker for individuals considered financially literate. If some individual investors persistently make fewer investment mistakes than their peers, then the question arises where this skill originates from. Feng and Seasholes (2005) show in their empirical study that investor sophistication (defined as static differences across investors) alone cannot explain why some investors are suffering from disposition effects while others are not. However, investor sophistication combined with experience (defined as an individual investors evolving behavior) together eliminates the reluctance to realize losses. List (2003) arrives at similar conclusions when studying the endowment effect in an experimental setting: Experience plays a significant role in elimi4

For a more comprehensive and detailed review and discussion of behavioral biases among investors, see, for example, Barberis and Thaler (2003) or Subrahmanyam (2007).

nating market anomalies. Similarly, Greenwood and Nagel (2009) find that inexperienced mutual fund managers are more likely to make investment mistakes. They document that compared to experienced managers, young managers show trendchasing behavior that lead to high losses during the dot-com bubble. Based on these findings, we hypothesize that at least some of the skill that differentiates individual investors who make investment mistakes from those that tend not to, is related to experience. That is, investors learn from their investment mistakes. The type of learning we have in mind is consistent with learning by doing. In his paper on the economic implications of learning by doing, Arrow (1962) points out that learning is the product of experience (p. 155). Building on the work of psychologists and economists, he argues that learning only happens through attempts to solve problems and therefore requires activity. Based on previous experience, individuals gain insights from the solution of problems that help them improve their future problem solving skills. The type of learning Arrow describes is in line with learning through Bayesian updating of posterior subjective beliefs (e.g., Kalai and Lehrer (1993)). Translated into the learning from mistakes that we expect to see among individual investors, our first hypothesis is: Hypothesis 1: As individual investors gain investment experience, they make fewer investment mistakes. Agarwal, Driscoll, Gabaix, and Laibson (2008) study the credit card market and find that individual households learn to avoid add-on fees related to late payment, over limit, and cash advance fees. They document that monthly fee payments are quite large immediately after the opening of the account, but then drop by 75% over the subsequent four years. Agarwal et al. conclude that learning from mistakes is driven by negative feedback: Paying fees teaches credit card holders to avoid triggering add-on fees in the future. Since the feedback mechanism is crucial for this kind of learning, it is questionable whether individuals will learn if they are not able to observe the outcomes of their decisions (e.g., Grossman, Kihlstrom, and Mirman (1977)). With reference to many investment mistakes, it may be difficult for the average investor to detect and avoid the given mistake because he or she is either not aware of its existence (e.g., background risks), is not able to measure and identify it (e.g., the disposition effect), or is not able to distinguish meaningful information from market noise (e.g., portfolio performance). We assume that the magnitude of learning relates to how easy it is for individual investors to detect and avoid an investment mistake. Our second hypothesis summarizes this argument: Hypothesis 2: Learning from investment mistakes is stronger for those investment mistakes that are easy to detect and avoid. If Hypothesis 1 holds, then the investment behavior of individual investors should converge with the predictions of orthodox finance theory as they gain experience. Thus, the gap between the portfolio and market returns should decrease as investors gain investment experience. And indeed, Seru, Schumway, and Stoffman (2010) provide evidence for a positive relationship between investment 4

experience and the returns earned by securities in the 30 trading days following a purchase. Similarly, Nicolosi, Peng, and Zhu (2009) find that trade quality (measured as average raw and excess buyminus-sell returns) increase as investors gain experience. As various studies have identified investment mistakes as a reason for reduced portfolio returns, we predict that an increase in investment experience leads to a reduction in investment mistakes, which in turn results in improved portfolio returns. This leads to our third hypothesis: Hypothesis 3: An increase in investment experience is associated with an increase in portfolio returns.

2. Data Description
We base this study on an administrative dataset provided by a large German branchless direct bank. The data includes the complete trading history (roughly 7 million transactions) across all asset classes of 19,487 individual investors between January 2000 and December 2007.5 The dataset consists of a file containing investor socio-demographics (such as gender, age, profession, self-reported risk appetite, etc.), a position file containing security-level monthly portfolio positions, and a table listing all transactions in the sample period. Dorn and Hubermann (2005), who use a similar dataset, note that in 2000 the five largest direct banks in Germany had nearly 1.5 million retail customers, which is a sizeable market share considering that at that point in time only 6.2 million Germans owned stocks (Deutsches Aktieninstitut (2009)). The success of direct banks in Germany is not surprising, considering that they combine low fees with a wide product offering, ranging from discount brokerage to financial planning and insurance products, which attracts a wide spectrum of clients. Contrary to clients of German universal banks which tend to sell the products of their asset management divisions (Dorn and Hubermann (2005)), direct bank customers are able to choose from the entire universe of securities and are accordingly institutionally unbounded. The investors in the sample are individual (private) investors, which means the data does not include accounts held by corporations, professional investment managers, or investment clubs. The investors are self-directed, which implies that they did not opt for the investment advice or financial planning services offered by the bank. To place orders, they can either log onto the banks website, send a fax or letter, or contact a call center agent. All investors opened their investment account during the observed time period, which means that we are able to observe their entire transaction history with the bank. Figure 1.1 summarizes how many investors per year entered and left the sample, as well as the number of investors trading per year. About 40% of the investors in the sample opened their account in the year 2000, while in each of the subsequent years roughly 10% started trading. The front loaded nature is not surprising when considering that overall stock market participation in Germany peaked in the year 2001 shortly after the height of the dot-com bubble. According to figures by the Deutsches
5

In this chapter we focus on 19,487 individual investors that opened their account during the observed time period, which is a subset of the overall dataset that includes 69,734 investors.

Aktieninstitut (2009), a German research association of listed companies and institutions, the number of Germans who own stocks or mutual funds increased from 5.6 million in 1997 to 12.9 million in 2001 and then dropped to 10.3 million in 2007. Table 1.1 presents summary statistics for the dataset. The socio-demographics in Panel A are self-reported by the investors at the point in time when they opened their account with the bank. The average age of the sample investors at account opening is 40.2 years, which is far

Figure 1: Sample Characteristics

The left part of Figure 1.1 presents the number of individual investors entering and exiting the sample per year. Entering is defined as the point in time when the investor opened the account with the bank and exiting is defined as the point in time when the investor closed his/her account. The right part of Figure 1.1 presents the number of investors who placed at least one trade in the given year. Transactions triggered by saving plans are excluded.

Investors Entering and Exiting

Investors entering sample Investors exiting s ample

Investor Participation
20,000 5,000 10,000 15,000

2,000 -2,000 0

4,000

6,000

8,000

2000 2001 2002 2003 2004 2005 2006 2007

0
2000 2001 2002 2003 2004 2005 2006 2007

below the average of the investor population (about 47 years) according to a representative survey conducted in the year 2000 on behalf of Deutsches Aktieninstitut (2009). The fact that the investors in the sample are considerably younger than the overall population leads us to the assumption that a large share of the sample investors had no or only limited investment experience before opening their investment account. This claim is further supported by a representative study conducted by the Federal Statistical Office of Germany (Statistisches Bundesamt (2004)), which in 2003 surveyed 74,600 households about their financial assets, real property, and debt. The results show that for households whose principal earner is between 25 and 45 years old (63.3% of the sample investors belong to this age bracket), financial assets account for about 25% of the average maximum lifetime financial assets. In other words, the investors in the sample tend to be at the beginning of their investment life cycle, and it is therefore more likely that we observe investment mistakes and subsequent learning from those mistakes.

With regard to other socio-demographic as well as investment portfolio characteristics, the sample investors are reasonably representative of the average German investor.6 According to figures provided by Deutsches Aktieninstitut (2009), 18% of German shareholders had an annual income of more than EUR 80k in 2000, which is close to the 22% of sample investors who earned more than EUR 75k. Similarly, 24% of the German shareholder population earned less than EUR 35k in 2000, which is comparable to the 13% of the sample investors that had incomes of less than EUR 25k. When looking at gender, we find that the sample includes more males compared to the overall German shareholder population (83% vs. 63%). The difference could be related to the sample selection, as the sample excludes investors who receive financial advice, which tend to include a higher share of females (e.g., Kramer (2009), Bhattacharya et al. (2010)). According to figures provided by the Deutsche Bundesbank (2010) and Deutsches Aktieninstitut (2009), the average German investor owned equities and mutual funds worth EUR 53.7k in the year 2000. On average, the investors in the sample owned equities and mutual funds worth EUR 21.3k when they opened their investment account. However, the difference between the sample and the population is not surprising when considering the young age of the sample investors. It is important to note that despite the fact that the value of the investment portfolio is smaller than for the overall population, the portfolios nevertheless are equal to a significant fraction of annual income for most investors. 78% of investors state that they earn less than EUR 75k per year, which translates into a disposable income (after deducting taxes, social security contributions, and health insurance premiums) of less than EUR 48k. This is roughly equal to twice the size of the average investment portfolio of the sample investors. Accordingly, it is unlikely that the portfolios represent play money accoun ts. Overall, even though we observe differences between the sample and the overall investor population in Germany in terms of socio-demographics and portfolio characteristics, we are reasonably confident that the sample is fairly representative. The differences seem to be related to the particular group of investors we are looking at, namely self-directed investors who only recently started investing in financial products.

When comparing our sample with the German investor population, we focus on the year 2000, because this is when the largest fraction of investors appeared in the sample for the first time.

Table 1: Summary Statistics

Table 1.1 presents summary statistics for socio-demographics (Panel A), portfolio and trading characteristics (Panel B), as well as asset allocation (Panel C) of the 19,487 investors in the sample. The socio-demographic data is taken from the account opening form submitted by the investor at account opening. The data on portfolio, trading, and asset allocation is measured over the first 12 months after the investor appeared in the sample.

Mean

25th Percentile 32.0 1.00 0.00 4.00 0.00 0.00

Median 38.0 1.00 1.00 5.00 0.00 0.00

75th Percentile 48.0 1.00 1.00 6.00 0.00 0.00

Panel A: Socio-Demographics Age (at account opening) 40.2 Gender (1 = male) 0.83 Married (1 = yes) 0.56 Risk appetite (1 = low to 6 = high) 4.51 Income below 25k EUR p.a. (1 = yes) 0.13 Income above 75k EUR p.a. (1 = yes) 0.22

Panel B: Portfolio and Trading Characteristics Investment portfolio (in EUR) 24,264 5,756 Transaction volume per month (in EUR) 18,842 910 Average trade volume (in EUR) 3,332 976 Active trades per month 4.22 0.33 Number of securities in portfolio 6.71 2.75 Risky asset share (in % of portfolio) 0.92 0.96 International securities (in % of portfolio) 0.43 0.14 Stocks in portfolio (1 = yes) 0.82 1.00 Mutual funds in portfolio (1 = yes) 0.49 0.00 Savings plan customer (1 = yes) 0.14 0.00 Portfolio returns (monthly average in %) -0.029 -0.051 Panel C: Asset Allocation Stock volume (in EUR) 15,494 1,027 Bond volume (in EUR) 667 0 Mutual fund volume (in EUR) 5,762 0 Investment certificates (in EUR) 1,163 0 Other asset classes (in EUR) 1,179 0 Stock volume (in % of portfolio ) 0.62 0.17 Bond volume (in % of portfolio ) 0.02 0.00 Mutual fund volume (in % of portfolio ) 0.27 0.00 Investment certificates (in % of portfolio ) 0.03 0.00 Other asset classes (in % of portfolio ) 0.07 0.00

13,650 2,927 2,009 1.17 5.00 1.00 0.40 1.00 0.00 0.00 -0.014

28,977 10,165 3,758 4.00 8.75 1.00 0.68 1.00 1.00 0.00 0.006

6,319 0 0 0 0 0.79 0.00 0.00 0.00 0.00

17,966 0 6,118 0 119 1.00 0.00 0.51 0.00 0.01

3. Empirical Methodology
3.1. Measuring Investment Mistakes

To test our hypotheses, we examine the relationship of investment experience and mistakes with regard to three investment mistakes: underdiversification, overconfidence, and the disposition effect. We focus on these investment mistakes for several reasons: First, they are well-documented by a number of empirical studies using different datasets and rank among the most cited investment mistakes in finance literature. Second, for each of the three investment mistakes a significant negative effect on investment performance has been documented (e.g., Goetzmann and Kumar (2008), Barber 8

and Odean (2000), Odean (1998a)). Third, they represent a wide spectrum of different investment mistakes, ranging from strategic and tactical asset allocation to suboptimal decisions related to investor psychology. To measure underdiversification, we adapt the approach outlined by Blume and Friend (1975) and approximate how closely an investors portfolio resembles the market portfolio. To do so, we follow Goetzmann and Kumar (2008) and calculate the sum of squared investment portfolio weights. This approach originated from competition and antitrust laws as the Herfindahl-Hirschman Index (HHI) and is used to measure the size of an individual firm relative to a given industry. We calculate HHI based on the following formula:

(1)

For each point in time t, wit is the investment portfolio weight of security we and wmt is the weight of security we in the market portfolio, and Nmt is the number of securities in the market portfolio. The idea behind the measure is that the number of securities in the market portfolio is very large and the corresponding weight of each individual security is very small. Hence, HHIt can be approximated by the sum of squared investment portfolio weights. HHIt will therefore be between one for an underdiversified portfolio with only one security and close to zero for well-diversified portfolios. Table 1.1 shows that 49% of the sample investors own at least one mutual fund, which typically consist of a large number of securities and are reasonably well-diversified. To account for this inherent diversification, we adapt the approach of Dorn and Hubermann (2005) and adjust HHIt by replacing mutual funds with a portfolio of 50 equal-weighted securities. We estimate HHIt for each investormonth observation using the position file containing security-level monthly portfolio positions. To generate investor-specific HHIt values per calendar year, we compute the (equal-weighted) average across all months the investor was active in a given calendar year. We consider an investor as active if he/she held at least one security in his/her portfolio. When we pool all investor-year observations, the mean HHIt value turns out to be 0.267 and the median 0.159. These values are close to the values reported by Dorn and Hubermann (2005) using a similar dataset. To measure overconfidence, we follow Barber and Odean (2000), who argue that overconfidence is closely related to excessive trading activity. Similar to Barber and Odean (2001), we approximate overconfidence by the monthly active portfolio turnover, which we calculate as one half the monthly active purchase turnover and one half the monthly active sales turnover. By active turnover we mean trades actively triggered by investors, which excludes transactions triggered by monthly saving plans. For each client and month, we compute the beginning-of-month value of the investment portfolio from the portfolio positions. The monthly active purchase turnover is then calculated by dividing the EUR volume of all purchases in the previous month by the portfolio value of the current month. The month9

ly active sales turnover is the EUR volume of all purchases in the current month divided by the current months portfolio value. If in a given month more securities are sold than held at the beginning of that month, then we assume the entire position is sold. Similarly, if fewer securities are held at the beginning of a given month than purchased in the previous month, we assume that the entire position was purchased in the previous month. Accordingly, our measure for active portfolio turnover will not exceed 100% per month. This restriction, however, affects less than 0.5% of the investors in the sample. The following formula summarizes the approach of calculating the monthly active portfolio turnover (APT): ( ) ( )

(2)

To calculate the active portfolio turnover per calendar year, we compute the (equal-weighted) average across all months per investor in a given calendar year. To avoid biases caused by investors who stopped trading but did not close their account, we only include the period between the first and last month the investor traded. However, since 83% of investors did not stop trading in the sample period, this convention is likely to affect only a small number of investors. When pooling all investors and years, the average active portfolio turnover is 13.7% per month and the median value is 4.6%. Those values are about twice the size that Barber and Odean (2001) report, who, however, used a dataset spanning from February 1991 to January 1997. Compared to our dataset, it did not include the dot-com bubble (which led to more trading activity7) and the subsequent rapid decline in equity markets (and therefore average portfolio values), which are both related to higher portfolio turnover. To measure the disposition effect, we adopt the methodology proposed by Odean in 1998 and which has since then been used in various studies and is probably the most widely-used method for testing the disposition effect empirically. Instead of counting the number of gains and losses realized, which would be biased since stock prices tend to rise, Odean defines the disposition effect as the difference between the proportion of gains realized (PGR) and of losses realized (PLR). In this context, PGR represents an investors willingness to sell winners (stocks that trade at above purchase price) and PLR represents the willingness to sell losers (stocks that trade at below purchase price). More specifically, Odean computes the following ratios:

(3)

(4)

Statman, Thorley, and Vorkink (2006) document that market-wide turnover is strongly positively related to lagged returns for many months.

10

For a given period t, a realized gain is counted when an investor sells a security at a price above the purchase price and a realized loss is counted when the investor sells a security at a price below the purchase price. For the securities that are not sold, a paper gain is recorded if the daily low is above the purchase price and a paper loss if the daily high is below the purchase price. No paper gain or loss is counted in case the purchase price lies between the daily high and low. On trading days where no securities are sold, no gains or losses are counted. To determine whether an investor suffers from the disposition effect (DEt), we simply compare PGRt and PLRt: If PGRt>PLRt, then an investor is more likely to realize gains than losses, which is evidence for the disposition effect. Formally, we define (5) which indicates that if DEt is larger than 0, an investor suffers from the disposition effect. Higher DEt values are associated with stronger disposition effects. In the empirical analysis, we compute PGRt and PLRt per calendar year over the period 2000 to 2008, which means that per investor we have a maximum of eight separate DEt estimates. For 14,801 of the investors we are able to compute at least two DEt estimates; on average, we are able to calculate 4.4 DEt estimates. Like Odean (1998a), we find that PGRt is significantly larger than PLRt: Pooled across all calendar years and investors, the average PGRt is 0.324 and the average PLRt is 0.185, resulting in an average DEt of 0.139. Figure 1.2 illustrates the distribution of the three investment mistakes of interest in the form of histograms.

11

Figure 2: Distribution of Investment Mistakes

Figure 1.2 illustrates the distribution of the Herfindahl-Hirschmann Index, Active Portfolio Turnover, and the Disposition Effect in the form of histograms. The vertical axis represents the fraction of the sample and the horizontal axis of the respective discrete intervals (bins). The data is pooled across all years and all sample investors.

Herfindahl-Hirschmann-Index
.2 .4

Active Portfolio Turnover

.15

.1

.05

.2

.4

.6

.8

0
0

.1

.2

.3

.2

.4

.6

.8

Disposition Effect (PGR-PLR)

.08 .02 0
-1

.04

.06

.1

-.5

.5

3.2.

Measuring Portfolio Returns

To calculate portfolio returns, we opt for the Modified Dietz Method (MDM). Despite that the dataset only includes monthly portfolio positions as opposed to daily portfolio valuations, MDM allows us to calculate a reasonable close approximation to the time-weighted rate of return (e.g., Shestopaloff and Shestopaloff (2007)). We compute portfolio returns according to MDM per investor and month using the following formula: ( ( ) )

where

(6)

EMVt denotes the end-of-month value of the investment portfolio, BMVt is the beginning-of-month market value, and CFt are the net contributions in the given month t, which comprise contributions to portfolio, withdrawals, and transaction fees. CFit represent the individual contributions, withdrawals, or transaction fees and Wit is a weight factor, which is calculated as the share of the total number of days in the month in which the contribution occurred. CDt is the total number of calendar days in the given month and Dit denotes the day of the month on which the investor made the contribution. We compute monthly returns for each investor and then derive the average (equal weighted) monthly return per calendar year.

12

As portfolio returns calculated according to the Modified Dietz Method do not account for differences in investment risk, we furthermore use two alternative measures of portfolio performance: First, we adopt the approach outlined by Jensen (1968) to calculate abnormal returns, which is widely known as Jensens Alpha. The measure captures the difference in returns realized by a given investment portfolio and a benchmark portfolio with the same systematic risk. We opt for a single factor over a multi factor model because recent studies (e.g., Carhart (1997) or Kosowski et al. (2006)) have shown that multi factor models offer no significant advantage over single factor models, i.e., the results remain the same. For each individual investor and calendar year, the model we use has the form: ( where is the monthly MDM portfolio return, ) (7)

is the average monthly yield-to-maturity of Ger8

man government bonds with one year to maturity in month t,

is the return in month t of the

CDAX index, a stock market index consisting of all German companies listed in the General or Prime Standard of Frankfurt Stock Exchange, is the sensitivity of the investors MDM portfolio returns to the market premium ( ), is the risk-adjusted return of the portfolio (Jensens Alpha), and t is

the error term. Figure 1.3 illustrates the distribution of MDM portfolio returns and Jensens Alpha. Second, we use the Sharpe Ratio as defined by Sharpe (1994) to calculate risk-adjusted portfolio returns. The ratio measures the portfolio return achieved in excess of the risk free rate of return compared to the portfolios riskiness as measured by the standard deviation of the differe ntial return. We use the following formula to calculate the Share Ratio for each investor and calendar year:

(8)

Where

is the MDM return of investment portfolio in month t,

is the average monthly yield-tois the standard

maturity of German government bonds with one year to maturity in month t, and deviation of the differential return over the period of one year.

We use a remaining maturity of one year because this maturity is the closest to the average holding period of securities in the sample.

13

Figure 3: Distribution of Portfolio Returns

The left part of Figure 1.3 presents the distribution of monthly MDM portfolio returns and the right part the distribution of Jensens Alphas. The vertical axis represents the fraction of the sample and the horizontal axis the respective discrete inte rvals (bins). The curves displayed are normal density estimates with identical mean and standard deviation as the distributions of the return measure. The data is pooled across all years and sample investors.

MDM Portfolio Returns

.2 .3

Jensen's Alphas

.15

.1

.05

-.2

-.1

.1

.2

0
-.2

.1

.2

-.1

.1

.2

3.3.

Measuring Investment Experience

To measure investment experience, we build on existing literature and derive three separate measures that proxy investment experience. First, we follow Seru, Shumway, and Stoffman (2010) who argue along the lines of learning by doing. They bring forward the argument that when investors make investment decisions, they will gain experience by observing the results of their investment decisions. Accordingly, we define the first experience measure as the cumulative number of active trades since account opening. 9 Figure 1.4 reports the distribution of investment experience among the sample investors. Second, we follow the argumentation of Nicolosi, Peng, and Zhu (2009) and use the time since account opening as a proxy for experience. Nicolosi et al. argue that investors with longer account tenures have more opportunities to infer their forecasting ability. Accordingly, they proxy experience by the number of months since account opening. To avoid biases caused by investors who opened their account but then did not trade, as well as econometric issues related to the limited variability in the change of the explanatory variable (it will increase by one month for all investors every month), we opt for an adjusted measure. Instead of counting all months since account opening, we only count those months in which the investor placed at least one trade. Accordingly, the second experience measure is the cumulative number of months traded since account opening. Third, we adopt the approach taken by Feng and Seasholes (2005), who study the disposition effect and proxy experience by the number of positions an investor has taken since opening his/her account.
9

By active we mean trades that are actively triggered by the investor, which excludes saving scheme trades.

14

They define positions as round trip transactions, which may include several buy and/or sell transactions, therefore allowing positions to build up. We take a similar approach and count the cumulative number of securities traded since account opening. By number of securities we mean the number of different ISIN codes traded.

Figure 4: Distribution of Experience Variables

The figures on the left side represent the average cumulative number of trades, months traded, and securities traded per year after account opening. The figures on the right side illustrate the distribution of number of trades, months traded, and securities traded in the sample period across all investors.

Cumulativ e No. of Trades

300 .2 .25

Dis tribution of No. of Trades

200

100

.05
0 1 2 3 4 5 6 7 8

0
0

.1

.15

200

400

600

800

1000

Years after Ac c ount Opening Cumulativ e No. of Months Traded

30 .06 .08 40

Trades in Sample Period Dis tribution of No. of Ac tiv e Months

20

10

.02
0 1 2 3 4 5 6 7 8

.04 0
0

20

40

60

80

100

Years after Ac c ount Opening Cumulativ e No. of Sec urities Traded

60 .15 80

Months Traded in Sample Period Dis tribution of No. of Sec urities Traded

40

20

.05
0 1 2 3 4 5 6 7 8

0
0

.1

50

100

150

200

250

Years after Ac c ount Opening

Sec urities Traded in Sample Period

3.4.

Empirical Model

To test the outlined hypotheses, we exploit the panel structure of the data and use a fixed effect regression model, which allows us to control for observed and unobserved time-invariant differences between individual investors. The model specification is motivated by previous studies of learning (e.g., Seru, Schumway, and Stoffman (2010)) and has the form:

15

(9) where the dependent variable yit+1 is either the investment mistake or portfolio return measure of interest for individual investor we in the year t+1. We use t+1 in order to estimate the influence of experience in a given year on the investment mistake or portfolio return in the following year. Experienceit represents the investor and year specific measure of investment experience, it is a vector of control variables to account for changes in the investors investment style (e.g., risk appetite) or in the market environment, t is an unobserved year fixed effect to capture differences between years that affect all investors, i is an unobserved individual investor effect, and it is a random error term potentially correlated within investor observations and possibly heteroskedastic (Petersen (2009)). The parameter of interest is 1, which represents the influence of experience on investment mistakes or portfolio returns. Seasholes and Zhu (2010) note that cross-correlation might be a serious issue in studies on private investor behavior. We address this issue by including year and investor fixed effects into our models. Additionally, we use clustered standard error according to Rogers (1993) in the reported tables.

4. Results and Discussion

Structured along the measures for investment mistakes and portfolio returns described in Section 1.4, this section presents our empirical results and discusses the findings.

4.1.

Learning from Underdiversification

Table 1.2 presents the estimation results with regard to learning from underdiversification for the sample of investor-year observations between 2000 and 2007. Specification (1) reveals that after removing both investor and year fixed effects, increases in experience as measured by the cumulative number of active trades are associated with decreases in diversification. Taking the estimates at face value shows that one hundred additional trades are related to an increase of the Herfindahl-Hirschman Index by 1.3 percentage points, which is a significant increase, considering the index scale from zero to one. Specification (2) incorporates additional explanatory variables that control for changes in the investors portfolio (value of investment portfolio, equity share) and changes in the market environment (level of CDAX stock market index). However, this has no impact on the results. Specification (3) uses the cumulative number of months (actively) traded to measure experience, however, the results remain similar to specifications (1) and (2). One additional month of active trading experience is associated with a 0.3 percentage point increase of the Herfindahl-Hirschman Index, which is a statistically highly significant increase. Including additional control variables does not change the picture. In specifications (5) and (6), we use the cumulative number of (different) securities traded to proxy experience, but again we see a significant negative relationship with diversification. 16

Trading one additional security is related to an increase of the Herfindahl-Hirschman Index by 0.1 percentage points. Adding control variables to the regression does not change our findings.

Table 2: Learning from Underdiversification

Table 1.2 presents the results of fixed effects panel regressions where the dependent variable is the investor and year specific portfolio Herfindahl-Hirschman Index, on a scale from 0 to 1, with smaller numbers representing a more diversified portfolio. Investment experience is measured either by the Cumulative no. of active trades, the Cumulative no. of months traded, or the Cumulative no. of securities traded since account opening. All regressions include investor and year fixed effects. The sample consists of investor-year observations between 2000 and 2007. Robust t-statistics, clustered by investor, are reported in parentheses, and ***, **, and * denote significance at 1%, 5%, and 10%, respectively.

Herfindahl-Hirschman Index Coefficient Cumulative no. of active trades (10 2 ) Cumulative no. of months traded Cumulative no. of securities traded Level of CDAX- index (in points) Value of investment portfolio (in EUR) Equity share (in % of portfolio) Intercept 0.346
(109.62)***

(1) 0.013
(3.97)***

(2) 0.013
(3.95)***

(3)

(4)

(5)

(6)

0.003
(21.63)***

0.003
(21.71)***

0.001
(11.59)***

0.001
(11.59)***

0.000
(19.36)***

0.000
(29.04)***

0.000
(24.22)***

0.000
(-1.10)

0.000
(-1.10)

0.000
(-1.10)

0.065
(6.67)***

0.065
(6.66)***

0.066
(6.70)***

0.121
(10.95)***

0.361
(116.40)***

0.075
(7.01)***

0.347
(115.80)***

0.116
(10.91)***

Investor fixed effects Year fixed effects Observations Unique investors Adjusted R

Yes Yes 112,724 19,477 0.654

Yes Yes 112,724 19,477 0.656

Yes Yes 112,724 19,477 0.654

Yes Yes 112,724 19,477 0.657

Yes Yes 112,724 19,477 0.652

Yes Yes 112,724 19,477 0.655

Despite the considerable benefits of diversification (e.g., Goetzmann and Kumar (2008)), individual investors apparently do not learn from underdiversification as they gain investment experience. Hirshleifer (2010) provides a possible explanation for this behavior. In his model, social interactions are the reason why investors choose to invest actively and thus frequently lose. To maintain their personal reputation, investors prefer to talk to peers about successful rather than poor investments. As picking few (preferably high idiosyncratic volatility) stocks is more likely to result in noteworthy investment victories than replicating the market portfolio, investors will opt for an active investment approach resulting in underdiversified portfolios. Hirshleifer concludes that active stock picking strategies will spread across the population unless sufficiently low mean returns offset the perceived benefits.

4.2.

Learning from Overconfidence

Table 1.3 presents the results of regressions with the active portfolio turnover as the dependent variable, which we use to proxy overconfidence. In specification (1) we use the cumulative number of trades to proxy experience. The estimation results show a significant negative relationship between 17

experience and overconfidence. One hundred additional trades are associated with a drop in (monthly) active portfolio turnover by 0.8 percentage points, which is a significant reduction considering that the average investor in the sample has an active portfolio turnover of 16.2% per month. Adding control variables for changes in the investor portfolio or market environment (specification (2)) does not lead to significant changes.

Table 3: Learning from Overconfidence

Table 1.3 presents the results of fixed effects panel regressions where the dependent variable is the investor and year specific portfolio Active Portfolio Turnover, on a scale from 0 to 1, with smaller numbers representing less trading activity. Investment experience is measured either by the Cumulative no. of active trades, the Cumulative no. of months traded, or the Cumulative no. of securities traded since account opening. All regressions include investor and year fixed effects. The sample consists of investor-year observations between 2000 and 2007. Robust t-statistics, clustered by investor, are reported in parentheses, and ***, **, and * denote significance at 1%, 5%, and 10%, respectively.

Active Portfolio Turnover Coefficient Cumulative no. of active trades (10 2 ) Cumulative no. of months traded Cumulative no. of securities traded Level of CDAX- index (in points) Value of investment portfolio (in EUR) Equity share (in % of portfolio) Number of securities in portfolio Intercept 0.262
(115.43)***

(1) -0.008
(-5.87)***

(2) -0.008
(-5.84)***

(3)

(4)

(5)

(6)

-0.002

-0.002 -0.000
(-4.10)***

(-13.53)*** (-13.55)***

-0.000
(-3.96)***

0.000
(32.04)***

0.000
(26.85)***

0.000
(34.56)***

0.000
(0.99)

0.000
(1.02)

0.000
(0.95)

-0.020
(-2.71)***

-0.020
(-2.69)***

-0.021
(-2.80)***

-0.001
(-4.52)***

-0.001
(-4.18)***

0.000
(-3.76)***

0.097
(12.41)***

0.254
(119.93)***

0.120
(15.40)***

0.263
(118.15)***

0.091
(11.81)***

Investor fixed effects Year fixed effects Observations Unique investors Adjusted R

Yes Yes 108,335 19,463 0.646

Yes Yes 108,335 19,463 0.646

Yes Yes 108,335 19,463 0.646

Yes Yes 108,335 19,463 0.646

Yes Yes 108,335 19,463 0.644

Yes Yes 108,335 19,463 0.644

In specifications (3) and (4) we use the cumulative number of months traded to measure investment experience. Again, we find a significant negative relationship between the measure of experience and active portfolio turnover, indicating that investors learn from this mistake as they gain experience. Specifications (5) and (6) present the results of regressions using the cumulative number of securities traded as an experience measure. Similar to the two previous measures for experience, we find a very

18

significant negative relationship between experience and active portfolio turnover. Adding control variables does not change our findings.10 The learning from overconfidence we observe is broadly consistent with the predictions of a learning model developed by Gervais and Odean (2001). In their multiperiod model, investors constantly observe the success of their investment decisions and thereby gradually infer about their own ability. When assessing their investment returns, investors take too much credit for successful investments and revise their beliefs about their own ability upward by too much. This leads to overconfidence among inexperienced investors, resulting in high levels of trading activity at the beginning of their careers. As investors gain investment experience, they learn to better recognize their own abilities and realize when their behavior is not beneficial. Overconfidence will diminish and their trading behavior will converge to rational behavior, leading to a gradual decrease in trading activity.

4.3.

Learning from the Disposition Effect

Table 1.4 presents the estimation results of regressions with the disposition effect as the dependent variable. As described in section 3.1, we estimate the disposition effect based on the methodology proposed by Odean (1998a) as the difference between the proportion of gains realized (PGR) and of losses realized (PLR). Since not every investor sold securities in every year of the sample period, we could not estimate the disposition effect for all investoryear combinations and consequently, the number of observations is lower compared to the previously discussed investment mistakes. Specifications (1) and (2) reveal that there is a positive relationship between the cumulative number of active trades and the disposition effect, which suggests that experience does not eliminate the investment mistake. When using the other two measures to approximate investment experience (specifications (3) to (6)), the results are similar. Increases in experience are related to significant increases in the disposition effect. Adding control variables that account for changes in the investor portfolio or market environment does not change our findings.

10

Note that in Table 3 the number of observations and that of unique investors included in the regression is slightly lower than in Table 2. For an investor-year observation to be included in the regression, we require the given investor to have been a customer of the bank for at least three months. If, for example, an investor started trading in November, then this investor-year observation is not included in the regression as there are only two months of portfolio turnover data available.

19

Table 4: Learning from the Disposition Effect

Table 1.4 presents the results of fixed effects panel regressions where the dependent variable is the investor and year specific portfolio Disposition Effect (PGR-PLR) on a scale from -1 to +1, with positive numbers representing the disposition effect. Investment experience is measured either by the Cumulative no. of active trades, the Cumulative no. of months traded, or the Cumulative no. of securities traded since account opening. All regressions include investor and year fixed effects. The sample consists of investor-year observations between 2000 and 2007. Robust t-statistics, clustered by investor, are reported in parentheses, and ***, **, and * denote significance at 1%, 5%, and 10%, respectively.

Disposition Effect (PGR-PLR) Coefficient Cumulative no. of active trades (10 2 ) Cumulative no. of months traded Cumulative no. of securities traded Level of CDAX- index (in points) Value of investment portfolio (in EUR) Equity share (in % of portfolio) Number of securities in portfolio Intercept 0.124
(20.87)***

(1) 0.008
(3.89)***

(2) 0.007
(3.81)***

(3)

(4)

(5)

(6)

0.002
(8.18)***

0.002
(8.26)***

0.001
(8.50)***

0.001
(8.66)***

0.000
(-11.35)***

0.000
(-6.95)***

0.000
(-10.85)***

0.000
(-0.43)

0.000
(-0.49)

0.000
(-0.42)

0.021
(1.45)

0.022
(1.50)

0.021
(1.45)

-0.002
(-3.85)***

-0.003
(-3.85)***

-0.003
(-3.96)***

0.295
(15.48)***

0.138
(20.80)***

0.257
(12.93)***

0.126
(21.64)***

0.287
(15.24)***

Investor fixed effects Year fixed effects Observations Unique investors Adjusted R

Yes Yes 68,262 17,102 0.317

Yes Yes 68,262 17,102 0.320

Yes Yes 68,262 17,102 0.317

Yes Yes 68,262 17,102 0.320

Yes Yes 68,262 17,102 0.318

Yes Yes 68,262 17,102 0.321

Our finding that experience and disposition effect are positively correlated contradicts the studies by Seru, Shumway, and Stoffman (2010), who find some evidence for a negative correlation, and Feng and Seasholes (2005), who find a strong negative relationship. We see two possible explanations for the difference in findings. First, both studies use a dataset from a period that differs from the period of our dataset. Seru, Shumway, and Stoffman use data from Finland that covers the years 1995 to 2003 and Feng and Seasholes use a Chinese dataset covering 1999 and 2000. In the sample from 2000 to 2007, we find a considerable variation among the average disposition effect estimates per calendar year, ranging from 0.08 to 0.15. Accordingly, it is difficult to compare results that use different sample periods, especially if they only include a few years of data as in the case of Feng and Seasholes. The second reason is related to the approach of estimating the disposition effect. Both studies use a hazard model to measure the disposition effect, which is different from the PGR-PLR approach used in the majority of empirical papers. In summary, we find that investment experience is associated with less overconfidence, but not less underdiversification or less disposition effect. Based on these findings, we cannot reject Hypothesis 1. 20

Interestingly, the reason why investors seem to learn from overconfidence but not the other two investment mistakes is potentially related to Hypothesis 2, which we cannot reject either. For individual investors it is very easy to identify and avoid the costs related to excessive trading caused by overconfidence. After each trade, the bank that provided us with the dataset sends an order confirmation to the customer, which lists all transaction related fees. If at the end of a year the customer realizes that his or her investment return is small compared to the transaction fees, then he or she can easily reduce trading activity in the next year. With regard to underdiversification and the disposition effect, the feedback investors receive is more ambiguous. It requires a lot more financial knowledge (and time) for the individual to detect the mistake and understand the costs associated with it. Accordingly, the chances that he or she will avoid the mistake are small.

4.4.

Learning and Portfolio Returns

Next, we turn to the question whether investors achieve higher portfolio returns as they gain experience. Specifications (1), (3), and (5) of Table 1.5 present the base regression estimates with portfolio returns estimated according to the Modified Dietz Method, inclusive of transaction fees 11 , as the dependent variable. The coefficients of all three experience variables are positive and significant either at the 1% or 5% level, indicating that investors indeed achieve higher portfolio returns as they gain investment experience. Specification (1) reveals that 100 additional active trades are associated with an increase in portfolio performance of 0.15% per month. With regard to experience measured by the number of active months, specification (3) reveals that one additional month of active trading is associated with an increase in monthly portfolio returns by 0.02%. Similarly, one additional traded security correlates with a rise in portfolio performance of 0.01% per month. Specifications (2), (4), and (6) incorporate control variables used in previous papers to address concerns regarding omitted variables. Studies of investment returns among individual investors have shown that portfolio value and equity share are positively related to investment performance (e.g., Kramer (2009)). To rule out that changes to the investment portfolio unrelated to learning affect the return estimates, we add the value of the investment portfolio and the equity share to the regression; however, this does not change our findings. Barber and Odean (2000) provide evidence that the average households gross returns (before transaction costs) are close to those earned by an investment in the market portfolio. However, net returns (after transaction costs) are significantly lower, leading to considerable underperformance relative to the market. They conclude that overconfident investors trade excessively and thereby generate transaction costs which substantially reduce portfolio returns. If the learning from overconfidence documented in section 4.2 is the reason for the increase in portfolio returns as investors gain experience, then this should be reflected in the difference between portfolio returns before and after accounting for
11

We define transaction fees as all costs related to executing a buy or sell order, such as fixed and variable commissions, over-the-counter transaction fees, phone or broker-assisted markups, foreign exchange fees, etc. In contrast to Barber and Odean (2000), our measure for transaction fees does not, however, include costs related to the bid-asks spread and market impact of a transaction.

21

transaction costs. The right part of Table 1.5 presents the regression results with portfolio returns that exclude transaction fees as the dependent variable. As expected, we find that the correlation between investment experience and returns before transaction fees is much weaker than for returns including fees. For two of the three experience variables, the coefficients are not different from zero at conventional levels of significance (specifications (8) and (10)), and for the third, the coefficient halved (specification (12)). Our estimates are conservative, because we only considered observable transaction costs. Apart from explicit commissions and other fees paid to the bank, there are also implicit transaction costs, such as the bid-ask spread and possibly market impact, which we cannot observe. Excluding these hidden costs from the portfolio returns before transaction fees would probably further weaken the relationship to investment experience. Since portfolio returns calculated according to the Modified Dietz Method do not control for differences in investment risk, we repeat the analysis using Jensens Alpha as well as the Sharpe Ratio as measures for risk-adjusted portfolio returns. The left part of Table 1.6 presents the regression estimates with Jensens Alpha as the dependent variable and the right part the r esults with the Sharpe Ratio as the dependent variable. Both measures are calculated including transaction fees. We find no significant correlation between investment experience and Jensens Alphas. The coefficients of two of the three experience measures are positive; however, they do not significantly differ from zero. Adding control variables for changes to the investment portfolio and to the regressions (specifications (2), (4), and (6)) does not change our findings. When using Sharpe Ratios instead, the results indicate a positive relationship between experience and risk-adjusted returns. For two of the three measures for investment experience they are significant at the 10% and 5% level, respectively.

22

Table 6: Experience and Risk-Adjusted Portfolio Returns

Table 1.6 presents the results of fixed effects panel regressions where the dependent variable is the investor and year specific Jensens Alpha or Sharpe Ratio, both calculated including transaction fees. Investment experience is measured either by the Cumulative no. of active trades, the Cumulative no. of months traded, or the Cumulative no. of securities traded since account opening. All regressions include investor and year fixed effects. The sample consists of investor-year observations between 2000 and 2007. Robust t-statistics, clustered by investor, are reported in parentheses, and ***, **, and * denote significance at 1%, 5%, and 10%, respectively.

Jensen's Alpha (1) -0.003

(-0.76) (-0.76) (1.28) (1.27)

Sharpe Ratio (5) 7.760 7.682 108.197

(1.90)*

Coefficient -0.003 0.009

(0.86) (0.83)

(2)

(3)

(4)

(6)

(7)

(8)

(9)

(10)

(11)

(12)

Cumulative no. of active trades (10 2 ) 0.009 0.006

(1.29) (1.29)

Cumulative no. of months traded (10 2 ) 0.006 0.000

(0.27)

104.894
(1.84)*

Cumulative no. of securities traded (10 ) 0.000

(0.03) (0.25)

66.772
(2.03)**

66.452
(2.02)**

Value of investment portfolio (in EUR) 0.016

(1.59) (1.56) (1.56)

0.000 0.016 -0.026

(-4.16)*** (-15.32)*** (-4.13)***

0.000
(0.47)

0.000
(0.17)

0.000
(0.21)

Equity share (in % of portfolio) -0.028

(-15.96)*** (-4.35)*** (-14.93)***

0.016 -0.026 -0.041

169.244
(2.37)** (-54.42)*** (-8.94)*** (-55.75)***

169.095
(2.37)** (-8.88)*** (-54.12)***

169.185
(2.37)** (-8.90)***

23
-0.043 -0.041 Yes Yes 108,743 19,441 0.048 108,743 19,441 0.048 108,743 19,441 0.048 108,743 19,441 0.048 108,743 19,441 0.048 Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes 108,743 19,441 0.048 Yes Yes 108,722 19,440 0.139

Intercept

-454.236 -612.969 -450.431 -609.134 -450.813 -609.422

Investor fixed effects Year fixed effects

Yes Yes 108,722 19,440 0.140

Yes Yes 108,722 19,440 0.139

Yes Yes 108,722 19,440 0.139

Yes Yes 108,722 19,440 0.139

Yes Yes 108,722 19,440 0.140

Observations Unique investors Adjusted R

Table 7: Robustness Checks for Learning from Investment Mistakes

Table 7 presents the results of fixed effects panel regressions where the dependent variable is a measure for underdiversification (specifications (1)-(3)), overconfidence (specifications (4)-(6)), or the disposition effect (specifications (7)-(9)) as listed on top of the column. Only the coefficients for the respective measure of experience are reported: Cumulative no. of active trades (specifications (1), (4), and (7)), Cumulative no. of months traded (specifications (2), (5), and (8)), Cumulative no. of securities traded (specifications (3), (6), and (9)). The first row (Entire Sample) reports estimates for the entire sample as in specifications (2), (4), and (6) of Tables 1.2, 1.3, and 1.4. The following rows present estimates for six subsamples of the entire sample as indicated in brackets. All regressions include investor and year fixed effects. The sample consists of investor-year observations between 2000 and 2007. Robust t-statistics, clustered by investor, are reported in parentheses, and ***, **, and * denote significance at 1%, 5%, and 10%, respectively.

Herfindahl-Hirschman Index Trades (1) 0.013

(3.95)*** (21.71)*** (11.59)*** (-5.84)*** (-13.55)***

Active Portfolio Turnover Trades (4) -0.008 -0.002 (5) (6) -0.000
(-3.96)***

Disposition Effect (PGR-PLR) Trades (7) 0.007

(3.81)***

Months (2) 0.003 0.001 (3)

Securities

Months

Securities

Months (8) 0.002

(8.26)***

Securities (9) 0.001

(8.66)***

Sample

Entire Sample

1st Subsample
(5.81)*** (14.15)*** (4.86)*** (-4.18)***

0.017 0.022
(6.86)*** (13.03)*** (9.81)***

0.006 0.006 0.003

(20.54)*** (10.04)***

0.001 0.001 0.001 0.001

(9.84)***

-0.005 -0.018
(-4.72)***

-0.002
(-6.54)***

-0.000
(-2.47)**

0.019
(2.87)***

0.007
(12.48)***

0.001
(2.44)**

24
0.012
(3.52)***

(investors from the highest mistake quintile) [n = 3,892 investors]

-0.004
(-8.92)***

-0.001
(-4.54)***

0.007
(2.27)**

0.002
(2.42)**

0.001
(4.56)***

2nd Subsample (investors that dropped out of the sample) [n = 3,470 investors]

-0.007
(-5.74)***

-0.001
(-11.64)***

-0.000
(-2.41)**

0.007
(3.44)***

0.002
(8.21)***

0.001
(7.80)***

3rd Subsample (investors that remained in the the sample) [n = 16,017 investors] 0.024
(6.89)*** (9.34)***

4th Subsample 0.008

(2.62)*** (13.75)***

0.004 0.004 0.003

(16.91)***

-0.017
(-5.84)***

-0.002
(-6.20)***

-0.000
(-3.23)***

0.018
(4.04)***

0.003
(3.93)***

0.001
(6.24)***

(investors from the first age quintile) [n = 3,495 investors]

5th Subsample 0.009

(2.57)**

0.001
(5.96)***

-0.006
(-4.32)***

-0.002
(-8.95)***

-0.000
(-3.40)***

0.000
(0.41)

0.000
(0.09)

0.000
(2.15)**

(excluding highest and lowest trading quintile) [n = 11,175 investors]

6th Subsample

0.001
(7.60)***

-0.008
(-4.13)***

-0.002
(-11.28)***

-0.000
(-3.65)***

0.005
(2.46)**

0.002
(6.81)***

0.000
(4.91)***

(excluding highest and lowest wealth quintile) [n = 11,689 investors] X X X

Controls

Level of CDAX- index (in points) Value of investment portfolio (in EUR) Equity share (in % of portfolio) Number of securities in portfolio

X X X

X X X

X X X X Yes Yes Yes Yes Yes Yes Yes Yes

X X X X Yes Yes

X X X X Yes Yes

X X X X Yes Yes

X X X X Yes Yes

X X X X Yes Yes

Fixed Effects

Investor fixed effects Year fixed effects

In summary, we find strong evidence for a positive relationship between investment experience and MDM portfolio returns (including fees), and some evidence for a positive association between experience and risk-adjusted portfolio returns. Accordingly, the previous findings by Seru, Schumway, and Stoffman (2010) that experience leads to higher returns over a 30-day period following purchases and by Nicolosi, Peng, and Zhu (2009) that trade quality increases, do translate into higher returns for the overall portfolio. We therefore cannot reject Hypothesis 3. The analysis of portfolio returns before and after accounting for transaction costs reveals that the increase in portfolio returns is indeed related to the learning from overconfidence we document in section 4.2. We assume that the reason why the evidence for risk-adjusted returns turns out to be weaker is related to our empirical methodology. Since we estimate risk-adjusted returns per calendar year, we only use 12 monthly MDM portfolio return observations to calculate Jensens Alpha and the Sharpe Ratio. We presume that this introduces considerable noise and leads to less significant results.

4.5.

Robustness Checks

To verify the robustness of our results with regard to learning from investment mistakes, we rerun the regressions using subsets of the original sample. We start by looking at those investors who are the most likely to suffer from the three investment mistakes we use in the study. The idea is that not all investors in the sample are underdiversified, suffer from overconfidence, or are subject to the disposition effect. By only looking at those most likely to suffer from these investment mistakes, we isolate those who are the most likely to learn from their mistakes. To do so, we divide the sample of investors into quintiles according to the magnitude of each investment mistakes in the first year investors appeared in the sample. We then rerun the regressions using only investors from the highest mistake quintile, those that are the most likely to suffer from the specific investment mistake. Table 1.7 presents the regression estimates. If we compare the estimates for this 1st subsample with the results of the entire sample, we find no differences. Hence, we conclude that our findings are not biased by investors who do not suffer from specific investment mistakes. Next, we turn to investors who stopped trading during the observed sample period. Seru, Schumway, and Stoffman (2010) argue that attrition plays an important role in the context of learning in financial markets. They find that a substantial amount of aggregate learning occurs when low-skilled investors learn about their poor abilities and consequently stop trading. Applied to our study this could mean that the learning we observe with regard to overconfidence could result from frequent (but unprofitable) traders leaving the sample and

25

not from learning on the individual level. To verify this, we split the sample into two parts: 3,470 investors that dropped out of the sample (2nd Subsample) and 16,017 investors that remained active until the end of the observed sample period (3rd Subsample). When comparing the two subsamples, we find that the regression results do not differ neither compared to each other, nor compared to the entire sample. Accordingly, we conclude that our findings are not biased by investor attrition related to learning about their poor abilities. Even though the sample only includes investors who began trading in the observed sample period, one might argue that investors previously held investment portfolios with other banks and therefore were not new to investing at the time they opened the account we observe. To address this concern, the 4th Subsample only includes investors from the lowest age quintile. All investors in this subsample were younger than 30 years when they opened their account; the average age at account opening was approximately 25 years. It is therefore unlikely that they held accounts with other banks before then. Table 1.7 illustrates that there is no difference in estimation results between the subsample of young investors and the overall sample. We therefore conclude that the results are not biased by investors that previously held accounts with other banks and entered the sample with prior investment experience. Finally, we turn to outliers among the investors in the sample. Among the 19,487 individual investors, we observe a wide spectrum of investment portfolio size, ranging from less than EUR 50 to more than EUR 10 million. Also, the trading frequency differs considerably: While some investors do not trade actively at all, there are some who trade more than 300 times month after month. To ensure that outliers are not driving our findings, we rerun the regression excluding investors in the highest and lowest investment portfolio quintile (5th Subsample) and the investors in the highest and lowest active portfolio turnover quintile (6th Subsample). The results presented in Table 1.7 show that there are no significant differences between the two subsamples and the overall sample. We therefore conclude that our results are not driven by outliers in terms of financial wealth or trading activity.

5. Summary and Conclusion

Motivated by empirical evidence which suggests that individual investors tend to make various investment mistakes that, in aggregate, lead to significant social costs, this paper examines whether investors actually learn from their mistakes. To address this question, we use a large administrative dataset which covers the complete trading history of 19,487 German retail investors over a period of eight years. We exploit the datasets panel structure to explore the relationship of three well doc umented investment mistakes underdiversification, overconfidence, and the disposition effect with three different measures for investment experience. We find that underdiversification and the disposition effect do not decline as investors gain investment experience. However, our results also show that gains in experience are associated with less portfolio turnover, suggesting that investors learn from overconfidence. We find that a gain in experience 26

equivalent to 100 additional trades is associated with a decline in monthly portfolio turnover of 0.8 percentage points, which is a significant reduction considering that the average investor in the sample has an active portfolio turnover of 16.2% per month. Our findings are robust to the inclusion of various control variables in the regression specification, including investor and year fixed effects, as well as measures for changes in the market environment and investment style. Furthermore, a number of additional robustness checks highlight that our results are not driven by investor attrition, investors with prior experience, or outliers in the sample. We conclude that compared to underdiversification and the disposition effect, it is relatively easy for investors to identify excessive trading activity, understand the nature and resulting costs of the mistake, and avoid it in the future. By correlating investment experience with portfolio returns, we are able to confirm the finding of previous studies that as investors gain experience, their investment performance improves. A comparison of portfolio returns before and after accounting for transaction costs reveals that the increase in portfolio returns is indeed related to learning from overconfidence. In light of the significant underperformance of individual investors, our findings suggest that learning from investment mistakes helps individual investors to close to some extent the performance gap to the overall market.

27

References
Agarwal, Sumit et al., 2008, Learning in the Credit Card Market, Working Paper, Federal Reserve Bank and National Bureau of Economic Research (NBER). Allen, Franklin, 2001, Do Financial Institutions Matter?, Journal of Finance 56, 11651175. Arrow, Kenneth J., 1962, The Economic Implications of Learning by Doing, Review of Economic Studies 29, 155173. Barber, Brad M. et al., 2009, Just How Much Do Individual Investors Lose by Trading?, Review of Financial Studies 22, 609632. Barber, Brad M., and Terrance Odean, 2000, Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors, Journal of Finance 55, 773806. Barber, Brad M., and Terrance Odean, 2001, Boys will be Boys: Gender, Overconfidence and Common Stock Investment, Quarterly Journal of Economics 116, 261292. Barberis, Nicholas C., and Richard Thaler, 2003, A Survey of Behavioral Finance, in Constantinides, G.M., M. Harris, and R. Stulz, ed.: Handbook of the Economics of Finance (Elsevier Science B.V., Amsterdam). Bauer, Rob, Mathijs Cosemans, and Piet Eichholtz, 2009, Option Trading and Individual Investor Performance, Journal of Banking & Finance 33, 731746. Benartzi, Shlomo, and Richard H. Thaler, 2001, Naive Diversification Strategies in Defined Contribution Saving Plans, American Economic Review 91, 7998. Benartzi, Shlomo, and Richard H. Thaler, 2007, Heuristics and Biases in Retirement Savings Behavior, Journal of Economic Perspectives 21, 81104. Bergstresser, Daniel, John M. R. Chalmers, and Peter Tufano, 2009, Assessing the Costs and Benefits of Brokers in the Mutual Fund Industry, Review of Financial Studies 22, 41294156. Bernheim, B. Douglas, and Daniel M. Garrett, 2003, The Effects of Financial Education in the Workplace: Evidence from a Survey of Households, Journal of Public Economics 87, 14871519. Bertrand, Marianne, Esther Duflo, and Sendhil Mullainathan, 2004, How Much Should We Trust Differences-in-Differences Estimates?, Quarterly Journal of Economics 119, 249275. Bhattacharya, Utpal et al., 2010, Do Retail Investors Benefit from Smart and Unbiased Financial Advice? Answers from a Large Field Study, Working Paper, Indiana University and Goethe University Frankfurt. Bluethgen, Ralph, Andreas Gintschel, Andreas Hackethal, and Armin Mller, 2008, Financial Advice and Individual Investors Portfolios, Working Paper, European Business School and Goethe University Frankfurt. Blume, Marshall E., Jean Crockett, and Irwin Friend, 1974, Stockownership in the United States: Characteristics and Trends, Survey of Current Business, 1614. Blume, Marshall E., and Irwin Friend, 1975, The Asset Structure of Individual Portfolios and Some Implications for Utility Functions, Journal of Finance 30, 585603. Brewer, William F., 2009, Implicit Learning and Tacit Knowledge, in Shanks, David, ed.: Psychology of Learning (SAGE, Los Angeles, London). Calvet, Laurent E., John Y. Campbell, and Paolo Sodini, 2007, Down or Out: Assessing the Welfare Costs of Household Investment Mistakes, Journal of Political Economy 115, 707747. Calvet, Laurent E., John Y. Campbell, and Paolo Sodini, 2009a, Fight or Flight? Portfolio Rebalancing by Individual Investors, Quarterly Journal of Economics 124, 301348. Calvet, Laurent E., John Y. Campbell, and Paolo Sodini, 2009b, Measuring the Financial Sophistication of Households, American Economic Review 99, 393398.

Camerer, Colin, and Dan Lovallo, 1999, Overconfidence and Excess Entry: An Experimental Approach, American Economic Review 89, 306318. Campbell, John Y., 2006, Household Finance, Journal of Finance 61, 15531604. Carhart, Mark M., 1997, On Persistence in Mutual Fund Performance, Journal of Finance 52, 5782. Choi, James J., David Laibson, Brigitte C. Madrian, and Andrew Metrick, 2002, Defined Contribution Pensions: Plan Rules, Participant Choices, and the Path of Least Resistance, Tax Policy and the Economy 16, 67113. Choi, James J., David Laibson, and Brigitte C. Madrian, 2005, $100 Bills on the Sidewalk: Suboptimal Investment in 401(k) Plans, Working Paper, National Bureau of Economic Research (NBER). Coval, Joshua D., David A. Hirshleifer, and Tyler Shumway, 2005, Can Individual Investors Beat the Market? Working Paper, Harvard University. DAB Bank, 2004, Faszination Wertpapier: Fakten und Hintergrnde zum Anlegerverhalten in Deutschland (DAB-Bank, Munich). De Bondt, Werner F. M., and Richard Thaler, 1985, Does the Stock Market Overreact?, Journal of Finance 40, 793805. Deutsche Bank Research, 2007, Retail Certificates: A German Success Story (Deutsche Bank AG, Frankfurt). Deutsche Bundesbank, 1985, Wertpapierdepotstatistik (Deutsche Bundesbank, Frankfurt). Deutsche Bundesbank, 2010, Wertpapierdepots Mrz 2010, Wertpapier-Kundendepots bei den einzelnen Bankengruppen (Deutsche Bundesbank, Frankfurt). Deutsches Aktieninstitut, 2009, DAI-Factbook 2009: Statistiken, Analysen und Graphiken zu Aktionren, Aktiengesellschaften und Brsen (Deutsches Aktieninstitut e.V., Frankfurt). Dhar, Ravi, and Ning Zhu, 2006, Up Close and Personal: Investor Sophistication and the Disposition Effect, Management Science 52, 726740. Dring, Diether, 2000, Grundlinien der langfristigen Systementwicklung der gesetzlichen Rentenversicherung: Personenkreis, Rentenformel, Finanzierung, in Fisch, Stefan, and Ulrike Haerendel, ed.: Geschichte und Gegenwart der Rentenversicherung in Deutschland: Beitrge zur Entstehung, Entwicklung und vergleichenden Einordnung der Alterssicherung im Sozialstaat (Duncker und Humblot, Berlin). Dorn, Daniel, and Gur Huberman, 2005, Talk and Action: What Individual Investors Say and What They Do, Review of Finance 9, 437481. Dow, James, and Gary Gorton, 1997, Noise Trading, Delegated Portfolio Management, and Economic Welfare, Journal of Political Economy 105, 10241050. Duflo, Esther, and Emmanuel Saez, 2003, The Role of Information and Social Interactions in Retirement Plan Decisions: Evidence from a Randomized Experiment, Quarterly Journal of Economics 118, 815842. Elton, Edwin J., and Martin J. Gruber, 2000, The Rationality of Asset Allocation Recommendations, Journal of Financial and Quantitative Analysis 35, 2741. Engelmann, Jan B. et al., 2009, Expert Financial Advice Neurobiologically Offloads Financial Decision-Making under Risk, PLoS One 4, e4957, 114. Feng, Lei, and Mark S. Seasholes, 2005, Do Investor Sophistication and Trading Experience Eliminate Behavioral Biases in Financial Markets?, Review of Finance 9, 305351. Finanztest, 2009, Am besten unabhngig (Stiftung Warentest, Berlin). Fishman, Peter, and Devin G. Pope, 2006, Punishment-Induced Deterrence: Evidence from the VideoRental Market, Working Paper, University of California, Berkeley. 29

Franke, Nikolaus et al., 2011, Provisions- und Honorarberatung: Eine Bewertung der Anlageberatung vor dem Hintergrund des Anlegerschutzes und der Vermgensbildung in Deutschland (Survey, Vallendar). French, Kenneth R., 2008, Presidential Address: The Cost of Active Investing, Journal of Finance 63, 15371573. French, Kenneth R., and James M. Poterba, 1991, Investor Diversification and International Equity Markets, American Economic Review 81, 222226. Gerhardt, Ralf, 2008, The Influence of Investors Jobs on Portfolios: Is there a Job Industry Bias?, Working Paper, Goethe University Frankfurt. Gerhardt, Ralf, and Andreas Hackethal, 2009, The Influence of Financial Advisors on Household Portfolios, Working Paper, Goethe University Frankfurt. Gervais, S., and Terrance Odean, 2001, Learning to be Overconfident, Review of Financial Studies 14, 127. Goetzmann, William N., and Alok Kumar, 2008, Equity Portfolio Diversification, Review of Finance 12, 433463. Goetzmann, William N., Lingfeng Li, and K. Geert Rouwenhorst, 2005, Long-Term Global Market Correlations, Journal of Business 78, 138. Greenwood, Robin, and Stefan Nagel, 2009, Inexperienced Investors and Bubbles, Journal of Financial Economics 93, 239258. Grinblatt, Mark, and Matti Keloharju, 2001a, How Distance, Language, and Culture Influence Stockholdings and Trades, Journal of Finance 56, 10531073. Grinblatt, Mark, and Matti Keloharju, 2001b, What Makes Investors Trade?, Journal of Finance 56, 589616. Grossman, Sanford J., Richard E. Kihlstrom, and Leonard J. Mirman, 1977, A Bayesian Approach to the Production of Information and Learning by Doing, Review of Economic Studies 44, 533547. Gruber, Martin J., 1996, Another Puzzle: The Growth in Actively Managed Mutual Funds, Journal of Finance 51, 783810. Guiso, Luigi, Michael Haliassos, and Tullio Jappelli, 2003, Household Stockholding in Europe: Where Do We Stand and Where Do We Go?, Economic Policy 18, 123170. Guiso, Luigi, and Tullio Jappelli, 2005, Awareness and Stock Market Participation, Review of Finance 9, 537567. Hackethal, Andreas, Michael Haliassos, and Tullio Jappelli, 2010, Financial Advisors: A Case of Babysitters?, Working Paper, Goethe University Frankfurt, University of Naples Federico II, CFS, CSEF, and CEPR. Haliassos, Michael, and Carol C. Bertaut, 1995, Why Do So Few Hold Stocks?, Economic Journal 105, 11101129. Heaton, John, and Deborah J. Lucas, 2000, Portfolio Choice in the Presence of Background Risk, Economic Journal 110, 126. Hirshleifer, David, 2010, Self-Enhancing Transmission Bias and Active Investing, Working Paper, Merage School of Business, UC Irvine, AFA 2011 Denver Meetings Paper. Hubrich, Stefan, and Thusnelda Tivig, 2006, Betriebsrenten im Altersversicherungssystem Deutschlands: eine Betrachtung aus volkswirtschaftlicher Sicht (Dt. Univ.-Verl., Wiesbaden). Hung, Angela A., and Joanne R. Yoong, 2009, Self-Dealing and Compensation for Financial Advisors, Working Paper, RAND Corporation Publications. Hung, Angela A., and Joanne R. Yoong, 2010, Asking For Help: Survey and Experimental Evidence on Financial Advice and Behavior Change, Working Paper, RAND Corporation Publications. 30

Inderst, Roman, and Marco Ottaviani, 2009, Misselling through Agents, American Economic Review 99, 883908. Inderst, Roman, and Marco Ottaviani, 2011, How (Not) to Pay for Advice: A Framework for Consumer Financial Protection, Working Paper, Goethe University Frankfurt and Kellogg School of Management, Northwestern University. Ivkovic, Zoran, Clemens Sialm, and Scott J. Weisbenner, 2008, Portfolio Concentration and the Performance of Individual Investors, Journal of Financial and Quantitative Analysis 43, 613656. Jacob, Nancy L., 1974, A Limited-Diversification Portfolio Selection Model for the Small Investor, Journal of Finance 29, 847856. Jansen, Christian, Ren Fischer, and Andreas Hackethal, 2008, The Influence of Financial Advice on the Asset Allocation of Investors, Working Paper, Goethe University Frankfurt. Jensen, Michael C., 1968, The Performance of Mutual Funds in the Period 19451964, Journal of Finance 23, 389416. Kalai, Ehud, and Ehud Lehrer, 1993, Rational Learning Leads to Nash Equilibrium, Econometrica 61, 10191045. Karabulut, Yigitcan, 2010, Financial Advice: An Improvement for Worse?, Working Paper, Goethe University Frankfurt. Karlsson, Anders, and Lars Norden, 2007, Home Sweet Home: Home Bias and International Diversification Among Individual Investors, Journal of Banking & Finance 31, 317333. Kelly, Morgan, 1995, All Their Eggs in One Basket: Portfolio Diversification of US Households, Journal of Economic Behavior & Organization 27, 8796. Kimball, Miles S., and Tyler Shumway, 2010, Investor Sophistication and the Home Bias, Diversification, and Employer Stock Puzzles, Working Paper, University of Michigan. Kosowski, Robert et al., 2006, Can Mutual Fund Stars Really Pick Stocks? New Evidence from a Bootstrap Analysis, Journal of Finance 61, 25512595. Kramer, Marc M., 2009, Investment Advice and Individual Investor Portfolio Performance, Working Paper, University of Groningen. Krausz, Miriam, and Jacob Paroush, 2002, Financial Advising in the Presence of Conflict of Interests, Journal of Economics and Business 54, 5571. Kumar, Alok, and Charles M.C. Lee, 2006, Retail Investor Sentiment and Return Comovements, Journal of Finance 61, 24512486. Leisering, Lutz, 2007, Privatisierung der Alterssicherung als komplexe Ordnungsbildung - Zur Entstehung von Wohlfahrtsmrkten und regulativer Staatlichkeit, in Becker, Ulrich, and Franz Ruland, ed.: Alterssicherung in Deutschland: Festschrift fr Franz Ruland zum 65. Geburtstag (Nomos, Baden-Baden). Leuven, Edwin, and Barbara Sianesi, 2003, PSMATCH2: Stata Module to Perform Full Mahalanobis and Propensity Score Matching, Common Support Graphing, and Covariate Imbalance Testing, Version: 4.0.3. List, John A, 2003, Does Market Experience Eliminate Market Anomalies?, Quarterly Journal of Economics 118, 4171. Lusardi, Annamaria, and Olivia S. Mitchell, 2007a, Baby Boomer Retirement Security: The Roles of Planning, Financial Literacy, and Housing Wealth, Journal of Monetary Economics 54, 205224. Lusardi, Annamaria, and Olivia S. Mitchell, 2007b, Financial Literacy and Retirement Preparedness: Evidence and Implications for Financial Education, Business Economics 42, 3544. Marc M. Kramer, 2009, Investment Advice and Individual Investor Portfolio Performance, Working Paper, University of Groningen. 31

Markowitz, Harry, 1952, Portfolio Selection, Journal of Finance 7, 7791. Mehra, Rajnish, and Edward C. Prescott, 2003, The Equity Premium in Retrospect, in Constantinides, George M., Milton Harris, and Ren M. Stulz, ed.: Handbook of the Economics of Finance (Elsevier/North-Holland, Amsterdam/Boston). Mehra, Rajnish, and Edward C. Prescott, 1985, The Equity Premium: A Puzzle, Journal of Monetary Economics 15, 145161. Mller, Armin, 2008, Anlageberatung bei Retailbanken: Einfluss auf das Anlageverhalten und die Performance von Kundendepots, PhD Dissertation, European Business School. Nicolosi, Gina, Liang Peng, and Ning Zhu, 2009, Do Individual Investors Learn from Their Trading Experience?, Journal of Financial Markets 12, 317336. Odean, Terrance, 1998a, Are Investors Reluctant to Realize Their Losses?, Journal of Finance 53, 17751798. Odean, Terrance, 1998b, Volume, Volatility, Price, and Profit When All Traders Are Above Average, Journal of Finance 53, 18871934. Odean, Terrance, 1999, Do Investors Trade Too Much?, American Economic Review 89, 12781298. Ottaviani, Marco, 2000, The Economics of Advice, Working Paper, University College London. Petersen, Mitchell A., 2009, Estimating Standard Errors in Finance Panel Data Sets: Comparing Approaches, Review of Financial Studies 22, 435480. Richter, Jrg, 2001, Grundstze ordnungsmiger Finanzberatung (Uhlenbruch, Bad Soden/Ts.). Rolfes, Bernd, 2007, Treibende Krfte der knftigen Rollenverteilung im Bankgeschft, in Tietmeyer, Hans, and Bernd Rolfes, ed.: Umbruch in der Bankindustrie: Zukunftsperspektiven und Strukturvernderung: Beitrge des Duisburger Banken-Symposiums (Gabler, Wiesbaden). Rogers, William H., 1993, Regression standard errors in clustered samples, Stata Technical Bulletin 13, 19-23. Rooij, Maarten van, Annamaria Lusardi, and Rob Alessie, 2007, Financial Literacy and Stock Market Participation, Working Paper, Center for Research on Pension and Welfare Policy. Samuelson, William, and Richard Zeckhauser, 1988, Status Quo Bias in Decision Making, Journal of Risk and Uncertainty 1, 759. Sauter, Nicolas, and Joachim Winter, 2010, Do Investors Respond to Tax Reform? Evidence from a Natural Experiment in Germany, Economics Letters 108, 193196. Scharfstein, David S., and Jeremy C. Stein, 1990, Herd Behavior and Investment, American Economic Review 80, 465479. Schmhl, Winfried, 2000, Entwicklungstendenzen der deutschen Alterssicherung im internationalen Vergleich. Jngere Erfahrungen und Perspektiven fr die Zukunft, in Fisch, Stefan, and Ulrike Haerendel, ed.: Geschichte und Gegenwart der Rentenversicherung in Deutschland: Beitrge zur Entstehung, Entwicklung und vergleichenden Einordnung der Alterssicherung im Sozialstaat (Duncker und Humblot, Berlin). Seru, Amit, Tyler Shumway, and Noah Stoffman, 2010, Learning By Trading, Review of Financial Studies 23, 705739. Shapira, Zur, and Itzhak Venezia, 2001, Patterns of Behavior of Professionally Managed and Independent Investors, Journal of Banking & Finance 25, 15731587. Sharpe, William F., 1994, The Sharpe Ratio, Journal of Portfolio Management 21, 4958. Shefrin, Hersh, and Meir Statman, 1985, The Disposition to Sell Winners Too Early and Ride Losers Too Long: Theory and Evidence, Journal of Finance 40, 777790. Shestopaloff, Yuri, and Alex Shestopaloff, 2007, A Hierarchy of Methods for Calculating Rates of Return, Journal of Performance Measurement 12, 3952. 32

Seasholes, Mark S., and Ning Zhu, 2010, Individual investors and local bias, The Journal of Finance 65, 1987-2010. Sirri, Erik R., and Peter Tufano, 1998, Costly Search and Mutual Fund Flows, Journal of Finance 53, 15891622. Statistisches Bundesamt, 2004, Einkommens- und Verbrauchsstichprobe, Geldvermgensbestnde und Konsumentenkreditschulden privater Haushalte, Fachserie 15, Heft 2 (Statistisches Bundesamt, Wiesbaden). Statman, Meir, Steven Thorley, and Keith Vorkink, 2006, Investor Overconfidence and Trading Volume, Review of Financial Studies 19, 15311565. Subrahmanyam, Avanidhar, 2007, Behavioural Finance: A Review and Synthesis, European Financial Management 14, 1229. Taylor Nelson Sofres, 2010, Ansichten und Einstellungen zur Finanzberatung im europischen Vergleich (Taylor Nelson Sofres plc., Munich). Thaler, Richard H., and Cass R. Sunstein, 2009. Nudge: Improving Decisions About Health, Wealth, and Happiness (Penguin Books, New York). Thaler, Richard H., and Shlomo Benartzi, 2004, Save More Tomorrow: Using Behavioral Economics to Increase Employee Saving, Journal of Political Economy 112, 164187. Trueman, Brett, 1988, A Theory of Noise Trading in Securities Markets, Journal of Finance 43, 83 95. Vyas, Seema, and Lilani Kumaranayaka, 2006, Constructing Socio-Economic Status Indices: How to Use Principal Components Analysis, Health Policy and Planning 21, 459468. Wilke, Christina B., 2009, German Pension Reform: On Road Towards a Sustainable Multi-Pillar System (Lang, Frankfurt am Main). Zhao, Xinge, 2005, Determinants of Flows into Retail Bond Funds, Financial Analysts Journal 61, 4759.

33