Larry Swedroe, Director of Research
“Investment Mistakes Even Smart Investors Make and How to Avoid Them,”covered 77 common errors I believe investors commit all too often. I know today there’s at least one more I should have included: discussing individual stock buys or sells at the water cooler.
Evidence from the field of psychology emphasizes the strength of face-to-face communication between individuals who frequently interact in producing and altering beliefs. Specifically, as it relates to investing, the study “Social Interaction and Stock Market Participation,” which appeared in the February 2004 issue of The Journal of Finance, found that social interaction leads to greater stock market participation.
The Role Of Social Interaction
Hans Hvide and Per Ostberg, authors of the study “Social Interaction at Work,” which was published in the September 2015 issue of the Journal of Financial Economics, contribute to the literature by examining the role that social interaction in the workplace can have on the investment decisions of individual investors.
The authors began with the conjecture that such interactions may influence or alter behavior. They write: “For example, investors pick among a dizzying number of individual stocks when evaluating which stock to purchase, and may obtain information from discussions with their colleagues, or make inferences based on hearing about their choices. Conversations with colleagues about stocks can also raise awareness of, or trust in, equity markets and make trading more likely.” They also wanted to see if workplace conversations influenced investment decisions in a positive or negative manner.
The authors matched employer-employee information (which covered the full population of Norway) that identified coworkers at the plant level. They combined the employer-employee data set with a complete record of common stock transactions made by individual investors at the Oslo Stock Exchange over the period January 1994 through December 2005.
They focused on individuals who made at least one purchase of common stocks over the sample period (about 12 percent of the population). They omitted the instances in which an individual was employed by a listed company or a subsidiary of a listed firm to avoid capturing mechanic effects of company stock plan transactions. The restrictions left an investor population of about 170,000.
The study’s results suggested strong social interaction effects. The following is a summary of the authors’ findings:
The stock market investment decisions of individuals are positively correlated with those of their co-workers.
A one-standard-deviation increase in co-worker trading activity results in an increase in trading activity of 41 percent relative to the unconditional mean.
A one-standard-deviation increase among the fraction of co-workers who purchase a particular stock is associated with a striking 195 percent increase in the fraction of that month’s purchases invested in the same stock.
Co-workers exert a greater influence on males.
There was no relationship to age or level of education.
Co-worker peer effects are present across local, nonlocal, same-industry and different-industry stocks.
A positive peer effect exists on sells, but is significantly smaller than on purchases.
Purchases made under stronger co-worker purchase activity are not associated with higher returns.
Social interaction appears to drive the purchase of within-industry stocks and local stocks. This is an investment mistake and represents a failure to diversify.
The impact of co-workers is larger for the purchase of within-industry stocks than for other stocks.
The results suggest a strong influence of co-workers on investment choices, but not an influence that improves the quality of investment decisions. In other words, they follow the advice of their co-workers even though the advice doesn’t contain value-pertinent information.
The authors reached the conclusion that, taken together, their findings “suggest that individuals are strongly influenced by their co-workers, but this influence does not improve, and sometimes reduces, the quality of their investment choices.”
They also concluded that their “results suggest that investment mistakes can be propagated by social interaction.” They then offered the following advice to individual investors: “Listening to co-workers is unlikely to improve the quality of investments.”
On the other hand, sometimes ignoring that advice can lead to investment mistakes, some of which may be difficult to recover from.
This commentary originally appeared October 9 on ETF.com.
About the Author
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 six 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)
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 CBSNews.com, Seeking Alpha, and Index Investor Corner on ETF.com.
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