Why Inexperienced Investors Do Not Learn

Why Inexperienced Investors Do Not Learn: They Don’t Know Their Past Portfolio Performance

Glaser and Weber just released a paper with the above title on SSRN. I urge you to download and read it. They examine the performance of 215 online investors over the past 4 years and find that the investors have no clue whatsoever as to how much money they made or lost. At the extreme, one investor who thought he had lost 50% per year had actually gained 2% per year. Another who thought she had gained 120% per year had lost 3% per year.

There was literally no correlation between the returns investors thought they had made and the returns they actually made. There was a tendency for those with better performance to be more accurate in assessing their past performance (they were better calibrated). This is a logical outcome–those investors who know how they did were more likely to allocate money to strategies that worked. So if they knew that they tended to lose money speculating in tech stocks, they would know to switch to something safer (index funds or blue chip stocks). That is why you should know your performance.

I am the poster boy for the importance of tracking performance. Since I started seriously investing in 2005 I have done all sorts of things–day trading, options, shorting stocks, speculating in gold, quantitative investing, value investing, and raw speculation. I know after tracking my performance in detail on Icarra that most of these things were not worthwhile. While I made a lot of money in gold I did not know what I was doing, so it made sense to get out. I lost money in day trading and got out with minuscule losses after only a week. I have made money shorting stocks. I have broken even on my options trading, mostly because I have gotten fairly good at shorting stocks and I used puts on a few stocks this summer that I could not borrow the shares to short. I have lost a lot of money in various stock speculation. When I have focused on finding and understanding good value stocks I have on the whole made money, doing slightly better than the market. My quantitative investing performance has been pretty darn spectacular.

So now that I know how I have performed, what will I do about it? I have forbidden myself from rank speculation in stocks or options. I have increased my short activity. I have limited the number of individual stock positions I pick for my value investing portfolio, increasing the size of each position, so that I can focus on better understanding each company. I have also drastically increased the portion of my portfolio that I allocate to quantitative strategies, both long and short.

So take a look at your performance. If it is okay, you may want to allocate more money to those strategies that are more profitable and less to those that are less profitable. If your performance is dismal, you may want to just stick all your investments in index funds. Remember, if you index, you can expect to outperform 80% of all investors, while spending a lot less time thinking about your investments.

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