Gender Differences
Psychologists have found that men are more overconfident than women in tasks perceived to be in the masculine domain. Although the finance industry has been slowly changing in the United States, investing has traditionally been considered a masculine task.
Therefore, men will generally be more overconfident about their ability to make investment decisions than women. As a consequence, male investors trade more frequently than female investors—their portfolios will have a higher turnover, a term used in the investment community that indicates the percentage of stocks in the portfolio that have changed, or turned over, during the year. For example, if a portfolio had a 50% turnover in a given year, the investor sold half the stocks in the portfolio during that year to purchase new stocks. Similarly, a 200% turnover is equivalent to an investor selling all the stocks in the portfolio to purchase others, then selling those stocks to purchase a third set, all during the same year.
Two financial economists, Brad Barber and Terrance Odean, examined the trading behavior of nearly 38,000 households that took place through a large discount brokerage between 1991 and 1997.2 They examined the turnover in brokerage accounts owned by men and women, both single and married. They found that single men trade the most. Single men trade at an annual turnover of 85%. This compares with an annual turnover of 73% for married men (apparently, having a woman in the house makes the man feel less confident).Married and single women have an annual turnover of 53% and 51%, respectively. Note that this is consistent with what psychologists say about men, women, and overconfidence—that is, men investors are more overconfident than women investors, leading to higher levels of trading.
Trading Too Much
Overconfident investors trade more. But is increased trading necessarily bad? If you receive accurate information and have a high ability to interpret it, then your trading should result in high returns due to your skill and the quality of your information. These returns should be high enough to beat a simple buy-and-hold strategy while covering the costs of trading. On the other hand, if you do not have high ability and are suffering a dose of overconfidence, then high degrees of trading will not result in portfolio returns large enough to beat the buy-and-hold strategy and to cover trading costs.
Barber and Odean also explored this issue, examining the relationship between turnover and portfolio returns.3 First they determined the level of trading for each investor; then they divided the investors into five groups. The 20% of investors having the lowest turnover composed the first group. On average, this group had a turnover of 2.4% per year—basically a buy-and-hold strategy. The next 20% of investors with low (but not the lowest) turnover made up the second group. They continued grouping this way until the investors with the highest turnover were placed into the fifth (and last) group. This last group experienced an average annual turnover of over 250% per year!
Note that all five groups earn the same 18.7% annually in gross returns—high-turnover investors did not end up picking better stocks for their additional efforts. But the excess trading does have a cost. Commissions must be paid for buying and selling stocks. Net returns (returns after commission costs) to the investor are much lower for the high-turnover group. The net returns for the lowest turnover group average 18.5% per year, versus 11.4% for the highest turnover group.
The net difference of 7% per year between the highest and lowest turnover groups is dramatic when we look at a simple example. Let’s say you and I both have $10,000 to invest for a period of five years and that I am in the lowest turnover group and you are in the highest. If I earn the 18.5% per year net return for my group, I will have $23,366 after five years of reinvesting my returns. If you, the overconfident investor, receive the 11.4% per year net return for the highest turnover group, you can expect only $17,156—a difference of over $5,000. The difference soars to over $200,000 in a 20-year period. During my retirement, I will be vacationing in Europe—I’ll send you a postcard.
Overconfidence-based trading is truly hazardous to accumulating wealth! One more thing: If men are more overconfident and trade more often than women, do male investors do worse than female investors? On average, the answer is yes. Overall, men earn nearly 1% less per year than women. Single men earn nearly 1.5% less per year than single women. This occurs even though men report having more investment experience than women. It’s probably experience learning to be overconfident.
Read More : Overconfidence and Trade Frequency
