Naïve *Buying* Diversification and Narrow Framing by Individual Investors

Abstract

We provide the first tests to distinguish whether individual investors equally balance their overall portfolios (naïve portfolio diversification-NPD) or engage in naïve buying diversification (NBD)-equally balancing values in same-day purchases of multiple assets. We find NBD in purchases of multiple stocks, and in mixed purchases of individual stocks and funds. In contrast, there is little evidence of NPD. So investors seem to narrowly frame their buy-day decision. Simulation analysis suggests that NBD substantially reduces investor welfare. These findings suggest that behavioral finance theory should incorporate transactional as well as portfolio framing.

Promotion and prevention focus orientation in mitigating the disposition effect.

“…Moreover, this is the first study to extend the previous calls in the literature in behavioral economics for mitigating behavioral biases (Burson et al, 2012) such as the DE (Frydman & Rangel, 2014). Our hypotheses and findings should motivate theorists to accommodate the role of implicit memory and psychological states in normative models that capture anomalies in asset pricing and portfolio choice, as for example in the home bias effect and naïve diversification (Gathergood et al, 2017). Finally, our findings have implications for financial institutions.…”

Go active or stay passive: Investment trust, financial innovation and diversification in Belgium's early days

“…Previous research documents that investors held an average of four stock holdings (Rutterford & Sotiropoulos, 2016b; and created equally-weighting stock portfolios (i.e. Gathergood et al, 2019;Rutterford & Sotiropoulos, 2016a). These facts serve as a justification to construct small portfolios.…”

Can Volatility Solve the Naive Portfolio Puzzle?

“…First, it is easy to implement as it relies on neither optimization nor estimation of the moments of asset returns. Second, investors continue to use such simple allocation rules for allocating their wealth across assets (Benartzi and Thaler, 2001;Baltussen and Post, 2011;De Giorgi and Mahmoud, 2018;Gathergood et al, 2019). Third, the naïve rule has been shown to consistently outperform mean-variance strategies (Jobson and Korkie, 1980;Michaud and Michaud, 2008;DeMiguel et al, 2009b;Duchin and Levy, 2009;Pflug et al, 2012).…”

“…In addition to these approaches, researchers have investigated the use of portfolio constraints (DeMiguel et al, 2009a;Kourtis et al, 2012;Behr et al, 2013). Recent papers find comparably poor performance using sophisticated hedging strategies to attempt beating naïve one-to-one hedging (Wang et al, 2015), provide behavioral evidence of naïve choice strategies (De Giorgi and Mahmoud, 2018;Gathergood et al, 2019), and identify the importance of volatility for portfolio performance (Moreira andMuir, 2017, 2019). Taking seriously the naïve strategy as an important benchmark, we explore improved econometric estimation of volatility as a potential source of out-of-sample performance.…”