By LARRY SWEDROE
To determine whether investor demographics provide information as to the holdings of their portfolios, Sebastien Betermier, Laurent Calvet, Samuli Knüpfer and Jens Kvaerner, authors of the February 2022 study What Do the Portfolios of Individual Investors Reveal About the Cross-Section of Equity Returns?, examined the stockholdings of 365,000 Norwegian individual investors over the period 1996-2017. Following is a summary of their key findings:
- Three principal components (market portfolio, investor age and investor wealth) explained 85 percent of the cross-section of investor portfolios versus just 25 percent for the market portfolio alone. The three components make up a wealth factor: a mature-minus-young factor, a high wealth-minus-low wealth factor, and the market factor.
- Age and wealth subsume other demographic factors including gender, occupation and education, although being female, having a graduate degree or business education and more stock market experience also predict a higher wealth factor tilt.
- Investors progressively adjust their stockholdings and therefore their factor tilts over the life cycle.
- Consistent with hedging demands, investors with high income beta-to-GDP growth (their income highly correlates with economic cycle risk) and high debt-to-income ratio tilt away from stocks with high economic cycle risks (such as value stocks).
- Relative to other investors, mature and wealthy investors tend to hold stocks with large market capitalisations, high book-to-market ratios (value stocks), high profitability, low investment, and low CAPM betas and have delivered significantly higher abnormal returns than the stocks owned by other investors. These are also stocks that tend to be owned by institutional investors, generally considered to be more sophisticated investors.
- Young and less wealthy investors are more likely to hold volatile stocks with high share turnover and low institutional ownership. These are the stocks about which investors disagree the most and in which arbitrage can be limited, allowing overpricing to persist (leading to poor returns).
- Female investors have a greater age factor tilt than male investors, and gender has approximately the same effect on the age factor tilt as ten years of stock market experience.
The role of investor sentiment
Another interesting finding is related to investor sentiment — the propensity of individuals to trade on noise (for example, overreacting to recent returns) and emotions rather than facts. Sentiment represents investors’ beliefs about future cash flows that the prevailing fundamentals cannot explain. Such activity can lead to mispricing. Eventually, any mispricing would be expected to be corrected when the fundamentals are revealed, making investor sentiment a contrarian predictor of stock market returns. As theory predicts, Betermier, Calvet, Knüpfer and Kvaerner found that investors prone to sentiment, such as men or investors with little stock market experience, no business education, or no professional experience in finance, tilt their portfolio away from the age and wealth factors, which outperformed. Their findings are consistent with those of the 2014 study Behavioral Finance, which found that sentiment co-varies with two key variables: age and wealth.
Betermier, Calvet, Knüpfer and Kvaerner’s findings that the portfolios of individual investors are linked to demographics are consistent with those of prior research:
- 1998, Boys Will Be Boys: Gender, Overconfidence, and Common Stock Investment: Biases such as overconfidence are more prevalent among men than women.
- 2006, Household Finance: The poor and less educated make significant mistakes.
- 2008, Fight or Flight? Portfolio Rebalancing by Individual Investors: Biases are more pronounced among investors with low education than among investors with high education.
- 2009, Inexperienced Investors and Bubbles: Young investors tend to be prone to fads and invest in bubbly stocks.
- 2015, Rich Pickings? Risk, Return, and Skill in the Portfolios of the Wealthy: Wealthier investors earn higher returns.
- 2017, Who Are the Value and Growth Investors?: Households progressively shift from growth to value as they become older and their wealth increases, and investors with high human capital and high exposure to macroeconomic risk tilt their portfolios away from value stocks.
- 2020, Heterogeneity and Persistence in Returns to Wealth: Wealthier investors earn higher returns.
Investor takeaways
The bad news is that investors who are young, male, less educated and have less investment experience have biases that lead them to make investment mistakes that lead to poor returns — mistakes that could likely be avoided if they spent the time to learn financial theory and made decisions based on peer-reviewed empirical research, not opinions. The good news is that Betermier, Calvet, Knüpfer and Kvaerner found that older investors earn superior returns — as investors age, they accumulate experience on the outcomes of past decisions, learn from past mistakes and end up making more efficient decisions. That finding is consistent with that of the 2010 study Learning by Trading. In other words, you can teach an old dog new tricks, and it’s never too early to learn how financial markets really work. For those interested in learning, I recommend Your Complete Guide to Factor-Based Investing.
For informational and educational purposes only and should not be construed as specific investment, accounting, legal, or tax advice. Certain information is based upon third party data which may become outdated or otherwise superseded without notice. Third party information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party websites. We are not responsible for the content, availability, or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products, or services available on or through them. The opinions expressed by featured authors are their own and may not accurately reflect those of Buckingham Strategic Wealth® or Buckingham Wealth Partners®, collectively Buckingham Wealth Partners. Neither the Securities and Exchange Commission (SEC), nor any other federal or state agency have approved, determined the accuracy, or confirmed the adequacy of this article. LSR-22-302
LARRY SWEDROE is Chief Research Officer at Buckingham Strategic Wealth and the author of numerous books on investing.
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