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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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“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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Mapping the field of behavioural biases: a literature review using bibliometric analysis
Jain, J., Walia, N., Singh, S., & Jain, E. (2021) · Management Review Quarterly · doi:10.1007/s11301-021-00215-y · Cited by 177
Barber, B. M., Terrance Odean, B., & Zhu, N. (2009) · Journal of Financial Markets · doi:10.1016/j.finmar.2009.03.003 · Cited by 370
“Attention is less of an issue for selling because most individual investors hold relatively few individual common stocks in their portfolio (Barber and Odean, 2000; Goetzmann and Kumar, 2008) and most individual investors do not sell short.”
Preferred Risk Habitat of Individual Investors
Dorn, D. T., & Huberman, G. (2010) · Journal of Financial Economics · doi:10.1016/j.jfineco.2010.03.013 · Cited by 132
“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…”
Beshears, J. L., Choi, J. J., Laibson, D., & Madrian, B. C. (2018) · National Bureau of Economic Research · doi:10.3386/w24854 · Cited by 76
Information, overconfidence and trading: Do the sources of information matter?
Abreu, M., & Mendes, V. (2012) · Journal of Economic Psychology · doi:10.1016/j.joep.2012.04.003 · Cited by 143
“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
“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).”
BackgroundDoes It Pay to Outclass? Corporate Social Responsibility and Its Impact on Firm Value
Ding, D. K., Ferreira, C., & Wongchoti, U. (2014) · International Review of Financial Analysis · doi:10.1016/j.irfa.2016.06.013 · Cited by 143
Zero-Commission Individual Investors, High Frequency Traders, and Stock Market QualityPreprint
Eaton, G. W., Green, T., Roseman, B. S., & Wu, Y.-B. (2021) · Social Science Research Network · doi:10.2139/ssrn.3776874 · Cited by 121
“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).”
Why Do Firms Use High Discount Rates
Jagannathan, R., Matsa, D. A., Meier, I., & Tarhan, V. (2016) · Journal of Financial Economics · doi:10.1016/j.jfineco.2016.01.012 · Cited by 117
“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).”
BackgroundHierarchical Clustering-Based Asset Allocation
Raffinot, T. (2017) · doi:10.3905/jpm.2018.44.2.089 · Cited by 116
Overconfidence, Investment Policy, and Executive Stock OptionsPreprint
Gervais, S., Heaton, J. B., & Odean, T. (2003) · SSRN Electronic Journal · doi:10.2139/ssrn.361200 · Cited by 116
Are extreme returns priced in the stock market? European evidence.
Annaert, J., de Ceuster, M. D., & Verstegen, K. (2013) · Journal of Banking & Finance · doi:10.1016/j.jbankfin.2013.05.015 · Cited by 115
“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).”
InfluentialWho Are the Value and Growth InvestorsPreprint
Betermier, S., Calvet, L., & Sodini, P. (2017) · SSRN Electronic Journal · doi:10.2139/ssrn.2426823 · Cited by 114
“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…”
InfluentialShareholder Diversification and the Decision to Go Public
Bodnaruk, A., Kandel, E., Massa, M., & Simonov, A. (2008) · doi:10.1093/rfs/hhm036 · Cited by 114
“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.”
Individual investors and gender similarities in an emerging stock market
Feng, L., & Seasholes, M. S. (2007) · Pacific-Basin Finance Journal · doi:10.1016/j.pacfin.2007.04.003 · Cited by 82
DOSPERT's Gambling Risk-Taking Propensity Scale Predicts Excessive Stock Trading
Markiewicz, Ł., & Weber, E. (2013) · Journal of Behavioral Finance · doi:10.1080/15427560.2013.762000 · Cited by 110
What factors affect behavioral biases? Evidence from Turkish individual stock investors
Tekçe, B., Yılmaz, N., & Bildik, R. (2016) · Research in International Business and Finance · doi:10.1016/j.ribaf.2015.11.017 · Cited by 126
“Goetzmann and Kumar (2008) find that high portfolio turnover, which is a sign of overconfidence is related to under-diversification.”
BackgroundCheon, Y.-H., & Lee, K.-H. (2017) · Management Sciences · doi:10.1287/mnsc.2017.2830 · Cited by 105
Chavas, J., & Falco, S. D. (2012) · doi:10.1111/j.1477-9552.2011.00319.x · Cited by 105
Financial Literacy and Mutual Fund Investments: Who Buys Actively Managed Funds?
Müller, S., & Weber, M. (2010) · Schmalenbach Business Review · doi:10.1007/bf03396802 · Cited by 134
Given enough eyeballs, all bugs are shallow? Revisiting Eric Raymond with bug bounty programs
Maillart, T., Zhao, M., Grossklags, J., & Chuang, J. (2016) · Journal of Cybersecurity · doi:10.1093/cybsec/tyx008 · Cited by 102
“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
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 242
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
Pricing Poseidon: Extreme Weather Uncertainty and Firm Return Dynamics
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
Diversification and portfolio theory: a review
Koumou, G. (2020) · Financial markets and portfolio management · doi:10.1007/s11408-020-00352-6 · Cited by 95
Hybrid Tail Risk and Expected Stock Returns: When Does the Tail Wag the Dog?Preprint
Bali, T. G., Cakici, N., & Whitelaw, R. F. (2014) · SSRN Electronic Journal · doi:10.2139/ssrn.1938606 · Cited by 94
“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
Reducing algorithm aversion through experience
Filiz, I., Judek, J. R., Lorenz, M., & Spiwoks, M. (2021) · Journal of Behavioral and Experimental Finance · doi:10.1016/j.jbef.2021.100524 · Cited by 88
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
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 95
FinVis: Applied visual analytics for personal financial planning
Rudolph, S., Savikhin, A., & Ebert, D. S. (2009) · IEEE Conference on Visual Analytics Science and Technology (VAST) · doi:10.1109/vast.2009.5333920 · Cited by 72
“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
Metadata
- 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 › Economics, Econometrics and Finance › Finance › 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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