Equity Portfolio Diversification
Abstract
This study shows that U.S. individual investors hold under-diversified portfolios, where the level of under-diversification is greater among younger, low-income, less-educated, and less-sophisticated investors. The level of under-diversification is also correlated with investment choices that are consistent with over-confidence, trend-following behavior, and local bias. Furthermore, investors who over-weight stocks with higher volatility and higher skewness are less diversified. In contrast, there is little evidence that portfolio size or transaction costs constrains diversification. Under-diversification is costly to most investors, but a small subset of investors under-diversify because of superior information.
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Highly literate investors tend to manage their risks significantly better than low literate individuals.
“Moreover, a number of studies has documented a positive link between financial literacy and portfolio diversification: highly literate investors tend to manage their risks significantly better than the group of low literate individuals (e.g., Calvet et al. 2007;Goetzmann and Kumar 2008;Guiso and Jappelli 2008;von Gaudecker 2015;Clark et al. 2015).”
From Financial literacy, financial advice, and financial behavior (2017) · cites this paper as Goetzmann and Kumar 2008
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“Goetzmann and Kumar (2001) and Polkovnichenko (2001) provide additional evidence on the lack of diversification of the equity portfolios of individual investors.”
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“(See, for example, Barber and Odean (2000), or Goetzmann and Kumar (2008).)”
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“Also, see the results in table 5 of Goetzmann & Kumar (2008).”
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Barber, B., & Odean, T. (2011) · SSRN Electronic Journal · doi:10.2139/ssrn.1872211 · Cited by 526 · see citing works
Financial literacy, financial advice, and financial behavior
Stolper, O. A., & Walter, A. (2017) · Journal of Business Economics · doi:10.1007/s11573-017-0853-9 · Cited by 471 · see citing works
“…in equity portfolios (Goetzmann and Kumar 2008; Grinblatt and Keloharju 2001), prior investment experience (Goetzmann and Kumar 2008; Nicolosi et al. 2009; Seru et al. 2010), and the propensity to invest in complex financial instruments (Genesove and Mayer 2001; Goetzmann and Kumar 2008).”
BackgroundInfluentialFinancial literacy and portfolio diversification
Abreu, M., & Mendes, V. (2010) · Quantitative Finance · doi:10.1080/14697680902878105 · Cited by 445 · see citing works
“Investors hold undiversified portfolios made up of a limited number of assets (Goetzmann and Kumar 2001, 2005, Guiso et al. 2002).”
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“A number of empirical studies find that many individual investors hold undiversified portfolios (see e.g. Blume and Friend, 1975; Dorn and Huberman, 2002; Campbell, 2006; Goetzmann and Kumar, 2008).”
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“Goetzmann and Kumar (2008) find that under-diversification is more prevalent among “less-sophisticated” investors.”
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“First, consistent with the recent work of Guiso et al. (2011), we show that investor’s risk tolerance is time-varying (see Fig.”
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“Goetzmann and Kumar (2001) find substantially concentrated portfolios in the individual brokerage accounts.”
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“7 For example, an informed investor may optimally focus on only a few stocks (Goetzmann and Kumar (2008), Ivkovich, Sialm, and Weisbenner (2008), Van Nieuweburgh and Veldkamp (2010)). broker.8 The database has been used by a number of other authors including Odean (1998) and Barber and Odean (2000).”
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“In addition to the socio-economic attributes used in Goetzmann and Kumar (2002), we consider investor experience and knowledge and the proxies for”
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“This underdiversification is typically not linked to investment skill (Goetzmann and Kumar 2008). If a portfolio optimizer improves diversification, it will consequently add value for a typical retail investor. It is relatively unimportant which optimization method is applied, as long as it increases diversification.…”
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“Goetzmann and Kumar (2008) show that individual investors not only hold a small number of stocks directly, but that the stocks that they do hold tend to be fairly highly correlated.”
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“Moreover, Goetzmann and Kumar (2001) show that the investors' portfolios were underdiversified relative to the extent of diversification possible when holding few stocks.”
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“Panel A of Figure 3 does this for the pure stock portfolios and reveals a picture of strong underdiversification, which is similar to the findings of Calvet et al. (2007) for Sweden and Goetzmann and Kumar (2008) for the U.S..”
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“Conditional on stock market participation, many households hold equity portfolios that are extremely underdiversified relative to mean-variance efficient benchmarks (Blume and Friend, 1975; Goetzmann and Kumar, 2008; Polkovnichenko, 2005).”
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“Second, following Merton (1987) and Goetzmann and Kumar (2002) , we propose that agents focus only on a subset of the most visible stocks.”
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“6See Goetzmann and Kumar (2008); Greenwood and Nagel (2009); Bilias et al. (2010).”
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“Most related to this paper is the work of Goyal and Saretto (2009), who form volatility assets (straddles and delta-hedged calls) and find a positive relation between volatility returns and the difference between historical realized volatility and implied volatility (HV-IV).”
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“Ambiguity aversion has also been used to think about the under-diversification in many household portfolios (Goetzmann and Kumar, 2008).”
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“…information would impair the ability to negotiate favorable financial terms and select investments with good riskadjusted returns, whereas a tendency to maintain current investment holdings would limit portfolio diversity (Goetzmann & Kumar, 2008; Korniotis & Kumar, in press; Kumar, 2007).”
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“…is not entirely clear whether certain investors hold few stocks because they are relatively unsophisticated and exhibit stronger behavioral biases (Goetzmann and Kumar (2008)), they exhibit a preference for skewness (Mitton and Vorkink (2007)), or they are resourceful and able to gather better…”
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“Barber and Odean (2000) and Goetzman and Kumar (2008) report similar findings of under-diversification based on data for individual investors at a U.S. brokerage.”
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“The main finding of this paper is not that individual investors tend to hold poorly diversified portfolios (as, for example, reported in Goetzmann and Kumar (2008)) or that they, in aggregate, display a preference for certain stocks (such as high-dividend stocks as reported in Graham and Kumar (2006)), or that an inve…”
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“Investor behavior may vary according to age (DaSilva & Giannikos, 2004), occupation (Christiansen, Joensenand, & Rangvid,, 2008) or the environment in which they live (Goetzmann & Kumar, 2008).”
Jacobs, H., Müller, S., & Weber, M. (2013) · Journal of Financial Markets · doi:10.1016/j.finmar.2013.07.004 · Cited by 149 · see citing works
“Second, many households own relatively few individual stocks, which may cause a significant exposure to idiosyncratic risk (e.g., Goetzmann and Kumar, 2008; Polkovnichenko, 2005).”
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“Research suggests that young investors are less financially literate (Van Rooij, Lusardi, and Alessie, 2011) and more prone to behavioral mistakes (Goetzmann and Kumar, 2008; Dhar and Zhu, 2006).”
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“Goetzmann and Kumar (2008) show that a large fraction of households are indeed poorly diversified, and the market appears to price idiosyncratic risk (e.g., Fu, 2009; Huang, Liu, Rhee, and Zhang, 2010).”
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“Although this is an idiosyncratic characteristic, demand by individual investors may lead to higher prices (and lower expected returns) for these stocks, given that these investors typically hold under-diversified portfolios, see e.g., Odean (1999) and Goetzmann and Kumar (2008).”
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“A recent literature suggests that the demand for positively-skewed “lottery” stocks could explain the under-diversification of household portfolios (Goetzmann and Kumar 2008, Kumar 2009b, Mitton and Vorkink 2007, Polkovnichenko 2005). While lottery stocks tend to be small and young growth stocks, it is unlikely that t…”
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“The first two measures are derived from Goetzmann and Kumar (2002); we refer the reader to their paper for a more extensive description of these proxies.”
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“Goetzmann and Kumar (2008) find that high portfolio turnover, which is a sign of overconfidence is related to under-diversification.”
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Maillart, T., Zhao, M., Grossklags, J., & Chuang, J. (2016) · Journal of Cybersecurity · doi:10.1093/cybsec/tyx008 · Cited by 102 · see citing works
“The strategy can be interpreted as portfolio diversification [54].”
Confirmation Bias, Overconfidence, and Investment Performance: Evidence from Stock Message BoardsPreprint
Park, J., Konana, P., Gu, B., Kumar, A., & Raghunathan, R. (2010) · SSRN Electronic Journal · doi:10.2139/ssrn.1639470 · Cited by 101 · see citing works
Self-citationThe Dynamics of Overconfidence: Evidence from Stock Market Forecasters
Deaves, R., Lüders, E., & Schröder, M. (2010) · Journal of Economic Behavior & Organization · doi:10.1016/j.jebo.2010.05.001 · Cited by 100 · see citing works
Does investor recognition predict returns
Bodnaruk, A., & Östberg, P. (2008) · Journal of Financial Economics · doi:10.1016/j.jfineco.2008.01.006 · Cited by 99 · see citing works
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Kruttli, M. S., Tran, B. R., & Watugala, S. W. (2019) · Finance and Economics Discussion Series · doi:10.17016/feds.2019.054 · Cited by 98
“Merton (1987) argues that this lack of diversification, which has been established empirically (see, for example, Polkovnichenko (2005) and Goetzmann and Kumar (2008)), can stem from investors only investing in securities that they know about, which leads to segmented markets.”
Utz, S. (2017) · Review of Financial Economics · doi:10.1016/j.rfe.2017.10.001 · Cited by 102 · see citing works
Diversification and portfolio theory: a review
Koumou, G. (2020) · Financial markets and portfolio management · doi:10.1007/s11408-020-00352-6 · Cited by 95 · see citing works
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Bali, T. G., Cakici, N., & Whitelaw, R. F. (2014) · SSRN Electronic Journal · doi:10.2139/ssrn.1938606 · Cited by 94 · see citing works
“Based on 40,000 stock accounts at a brokerage firm, Goetzmann and Kumar (2008) find that the median number of stocks in a portfolio of individual investors is three in the 1991-1996 period.”
Availability, recency, and sophistication in the repurchasing behavior of retail investors
Nofsinger, J. R., & Varma, A. (2013) · Journal of Banking & Finance · doi:10.1016/j.jbankfin.2013.02.023 · Cited by 121 · see citing works
Reducing algorithm aversion through experience
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Do financial experts make better investment decisions?
Bodnaruk, A., & Simonov, A. (2015) · Journal of Financial Intermediation · doi:10.1016/j.jfi.2014.09.001 · Cited by 87 · see citing works
Out of control or right on the money? Funder self-efficacy and crowd bias in equity crowdfunding
Stevenson, R. M., Ciuchta, M. P., Letwin, C. R., Dinger, J. M., & Vancouver, J. B. (2018) · Journal of Business Venturing · doi:10.1016/j.jbusvent.2018.05.006 · Cited by 87 · see citing works
FinVis: Applied visual analytics for personal financial planning
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“However, individuals have cognitive limitations and cannot effectively use this strategy for financial planning, and this has been discovered in the field [10, 12] and in laboratory experiments [20, 5].”
BackgroundOn the Relation between EGARCH Idiosyncratic Volatility and Expected Stock Returns
Guo, H., Kassa, H., & Ferguson, M. (2014) · Journal of Financial and Quantitative Analysis · doi:10.1017/s0022109014000027 · Cited by 83
- Authors
- Goetzmann, W. N., & Kumar, A.
- Affiliations
- Yale University (US)
- The University of Texas at Austin (US)
- ORCID
- Kumar, Alok
- Venue
- Review of Finance
- Publisher
- Oxford University Press (OUP)
- Published
- 2008-01-01
- Volume
- 12
- Issue
- 3
- Pages
- 433-463
- ISSN
- 1382-6662 (ISSN-L)
- 1573-692X
- 1572-3097
- OpenAlex
- W3122442489
- Cited by
- 1,222
- References
- 0
- Citations by year
- 2026: 50 · 2025: 64 · 2024: 101 · 2023: 47 · 2022: 77 · 2021: 80 · 2020: 85 · 2019: 68 · 2018: 72 · 2017: 88 · 2016: 76 · 2015: 55 · 2014: 71 · 2013: 65 · 2012: 69
- FWCI
- 78.63
- Type
- journal article
- Language
- en
- Open access
- closed
- Locations
- European Finance Review (publishedVersion)
- RePEc: Research Papers in Economics (submittedVersion)
- Topics
- Social Sciences › Economics, Econometrics and Finance › Finance › Financial Markets and Investment Strategies
- Social Sciences › Business, Management and Accounting › Accounting › Financial Literacy, Pension, Retirement Analysis
- Social Sciences › Decision Sciences › General Decision Sciences › Decision-Making and Behavioral Economics
- Keywords
- portfolio diversification, under-diversification, retail investors, investor sophistication, overconfidence, local bias, stock market volatility, skewness, investor demographics, portfolio size, transaction costs, diversification costs
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