Library of Congress Report: Behavioral Patterns of U.S. Investors
The Library of Congress’s Federal Research
Division, at the request of the SEC’s Office of Investor Education and
Advocacy, recently prepared a report and bibliography on the behavioral traits
of U.S. investors. The Library of Congress’s report identifies common
investing mistakes that can undermine investment performance. The Report
is available in its entirety here.
The Report presents the findings of the Library of Congress author, based on
research and analysis adhering to accepted standards of scholarly objectivity.
The findings do not necessarily reflect the views of the SEC, its
Commissioners, or other members of the SEC’s staff.
For information on investing generally, as
well as on the federal securities laws and the Securities and Exchange
Commission, please visit www.SEC.gov.
What investing behaviors undermine investment performance?
The Library of Congress report identifies
nine investing behaviors that can undermine investment performance. These
behaviors include: active trading; the disposition effect; focusing on past
performance and ignoring fees; familiarity bias; mania and panic; momentum
investing; naďve diversification; noise trading; and inadequate
- Active Trading:
An investor using an active trading investment strategy engages in regular,
ongoing buying and selling of investments. This kind of investor purchases
investments and continuously monitors their activities in order to take
advantage of profitable conditions in the market. The Report concludes that
active trading generally results in the underperformance of an investor’s
- Disposition Effect:
The disposition effect is the tendency of an investor to hold on to losing
investments too long and sell winning investments too soon. In the months
following the sale of winning investments, these investments often continue to
outperform the losing investments still held in the investor’s portfolio.
- Focusing on Past Performance of Mutual Funds and Ignoring Fees: When deciding to
purchase shares in a mutual fund, the Report indicates that some investors
focus primarily on the mutual fund’s past annualized returns and tend to
disregard the fund’s expense ratios, transaction costs, and load fees, despite
the harm these costs and fees can do their investment returns.
- Familiarity Bias:
Familiarity bias refers to the tendency of an investor to favor investments
from the investor’s own country, region, state or company. Familiarity bias
also includes an investor’s preference for “glamour investments”; that is,
well-known and/or popular investments. Familiarity bias may cause an
investor’s portfolio to be inadequately diversified, which can increase the
portfolio’s risk exposure.
- Manias and Panics:
Financial “mania” or a “bubble” is the rapid rise in the price of an
investment, reflecting a high degree of collective enthusiasm or exuberance regarding
the investment’s prospects. This rapid rise is usually followed by a
contraction in the investment’s price. The contraction, or “panic” occurs when
there is wide-scale selling of the investment that causes a sharp decline in
the investment’s price.
- Momentum Investing:
An investor using a momentum investing strategy seeks to capitalize on the
continuance of existing trends in the market. A momentum investor believes
that large increases in the price of an investment will be followed by additional
gains and vice versa for declining values.
- Naďve Diversification:
Naďve diversification occurs when an investor, given a number of investment
options, chooses to invest equally in all of these options. While this
strategy may not necessarily result in diminished performance, it may increase
the risk exposure of an investor’s portfolio depending upon the risk level of
each investment option.
- Noise Trading:
Noise trading occurs when an investor makes a decision to buy or sell an
investment without the use of fundamental data (that is, economic, financial,
and other qualitative or quantitative data that can affect the value of the
investment). Noise traders generally have poor timing, follow trends, and
overreact to good and bad news in the market.
- Inadequate Diversification:
Inadequate diversification occurs when an investor’s portfolio is too
concentrated in a particular type of investment. Inadequate diversification
increases the risk exposure of an investor’s portfolio.
For additional information on saving and
investing, please see our publication Saving and
Investing: A Roadmap to Your Financial Security Through Saving and Investing (also available in Spanish). For information
on questions you should ask when considering an investment, see Ask Questions:
Questions You Should Ask About Your Investments (also available in
Library of Congress Report and Annotated
Bibliography on Investor Behavior.