(MoneyWatch) Regular readers of this blog know that we make all sorts of mistakes as investors. In fact, we make so many that one of my books -- "Investment Mistakes Even Smart Investors Make and How to Avoid Them" -- discussed 77 such behaviors and still doesn't cover all the dumb stuff we do. But there's hope. A new study shows that investors can improve their investing returns by learning from their blunders.
The paper "Getting Better: Learning to Invest in an Emerging Stock Market" studied the Indian stock market to see if investors truly learn as they gain investing experience.
- India is an emerging market whose capitalization and investor base have been growing rapidly. In such a population of relatively inexperienced investors, learning may be faster and easier to detect than in better-established equity markets.
- Mutual funds account for a relatively small value share of Indian individuals' stock exposure, making it meaningful to measure the diversification of directly held stock portfolios.
The authors focused on three main behaviors: Underdiversification, high turnover and the disposition effect, which means selling stocks that have appreciated while holding on to stocks that have depreciated. (The disposition effect hurts investors by increasing the present value of tax obligations.) The following is a summary of their four main findings:
- Investment performance improved with experience.
- Two of the three potentially harmful investment behaviors that they focused on -- high turnover and the disposition effect -- are less prevalent among older accounts.
- All three investment behaviors diminish in response to painful experiences, including account underperformance, large losses in a single month and poor returns from past trading and sales of gains.
- Older accounts tilt more toward value stocks, which have higher expected returns.
Summarizing, Indian investors appear to learn from stock market participation at a rate that's influenced by their investment experiences. I wish we could say the same for U.S. investors, where learning is painfully slow. If U.S. investors learned quickly from their behaviors, we would see a much faster pace of assets leaving actively managed funds and stockbrokers and moving to passively managed funds and registered investment advisors who provide a fiduciary standard of care. There certainly is a trend, but it's moving at a glacial pace