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BAM Intelligence

Investors Respond to Feedback

It’s been well documented that, on average, retail investors are “dumb” money. For example, on average, the stocks they buy go on to underperform, and the stocks they sell go on to outperform. Sadly, investors even manage to underperform the very mutual funds in which they invest.

And, by the way, men do worse than women (due to excessive confidence in skills they do not have), investment clubs perform even worse than individuals (proving that when it comes to investing, more heads may not be better than one), and those who trade the most tend to underperform by the most (again, likely due to overconfidence).

An interesting question is whether the performance of individual investors could be improved by providing them feedback and showing them how poorly they were doing. Steffen Meyer, Linda Urban and Sophie Ahlswede, authors of the study “Does Feedback on Personal Investment Success Help?”, sought the answer to that question. Their study is a working paper by SAFE (Sustainable Architecture for Finance in Europe), a cooperation of the Center for Financial Studies and Goethe University.

Survey Says …

The authors note that most banks don’t provide investors with feedback on their investment decisions. In fact, a survey they cite found only one out of 120 banks in Germany regularly informed their customers about the risks, costs and return of their portfolios over the prior year.

It found all other financial services providers fulfill only their statutory duties and provide information on holdings, volumes, current market prices, position value and, in some cases, the position’s purchase price. There is no information on the portfolio other than its current total value.

A skeptic would say it’s easy to explain this failure to report: If they provided that information, they believe their clients would stop some of the bad behavior, leading to lower profits for the banks.

Does Feedback Help Investors?

To explore the feedback question, Meyer, Urban and Ahlswede tested what happened when they provided more than 1,500 customers of an online broker with repeated feedback on their investment success in a monthly securities account report.

The reports showed investors their last year’s returns, costs, their current level of risk and their portfolio diversification. The test lasted 18 months. All the investors in their sample traded heavily, with an average annual turnover of well above 100% and a median turnover of 98%.

It’s important to note that survey participants stated they did not use their account as “play money accounts,” with 72% of participants reporting that the account associated with the survey is their main securities account. Only 3% said they had a short-term investment horizon. The authors found that after receiving the feedback reports:

  • Investors trade less
  • Investors diversify more
  • Investors earn higher risk-adjusted returns
  • The effects become stronger over time

There was another interesting result. Prior research has shown that individual investor learning in investment matters is mainly driven through attrition—investors who learn about their inferior investment skills stop trading. When this study was controlled for attrition, the authors were unable to explain their results.

These results were statistically significant as well as robust to controlling for potential play money accounts and changes in report designs. The authors also found that effects do not differ much between different report designs—it is more important to provide investors with relevant feedback than it is to deliver it in a specific format.

They also found that their results did not change if they focused only on the very literate investors. Meyer, Urban and Ahlswede concluded that even basic reporting “could help regular stock market participants, who often do not know their costs, diversification and performance.” This begs the question: Do you know how you are doing in terms of costs, diversification and risk-adjusted performance?

This commentary originally appeared February 17 on ETF.com

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The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

© 2017, The BAM ALLIANCE

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Chief Research Officer

Larry Swedroe is Chief Research Officer for the BAM ALLIANCE.

Previously, Larry was vice chairman of Prudential Home Mortgage. Larry holds an MBA in finance and investment from NYU, and a bachelor’s degree in finance from Baruch College.

To help inform investors about the evidence-based investing approach, he was among the first authors to publish a book that explained evidence-based investing in layman’s terms — The Only Guide to a Winning Investment Strategy You’ll Ever Need. He has authored 15 more books:

What Wall Street Doesn’t Want You to Know (2001)
Rational Investing in Irrational Times (2002)
The Successful Investor Today (2003)
Wise Investing Made Simple (2007)
Wise Investing Made Simpler (2010)
The Quest for Alpha (2011)
Think, Act and Invest Like Warren Buffett (2012)
The Incredible Shrinking Alpha (2015)
Your Complete Guide to Factor-Based Investing (2016)
Reducing the Risk of Black Swans (2018)
Your Complete Guide to a Successful & Secure Retirement (2019)

He also co-authored four books: The Only Guide to a Winning Bond Strategy You’ll Ever Need (2006), The Only Guide to Alternative Investments You’ll Ever Need (2008), The Only Guide You’ll Ever Need for the Right Financial Plan (2010) and Investment Mistakes Even Smart Investors Make and How to Avoid Them (2012). Larry also writes blogs for MutualFunds.com and Index Investor Corner on ETF.com.

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