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Retail Investors and ‘Noise’ Trading

Investors often chase attention-grabbing stocks and severely underperform the market due to active trading.

By Larry Swedroe | Feb 14, 2023

Research has found that retail investors tend to be naive “noise traders” who trade on sentiment rather than on fundamentals.

In a series of papers, Brad Barber and Terrance Odean demonstrated that retail investors are susceptible to behavioral biases such as overconfidence, often chase attention-grabbing stocks, and severely underperform the market due to active trading.

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The Nonsensical Growth of Hedge Funds

Hedge funds are investment pools that are relatively unconstrained in what they do. They are relatively unregulated (for now), charge very high fees, will not necessarily give you your money back when you want it, and will generally not tell you what they do. They are supposed to make money all the time, and when they fail at this, their investors redeem and go to someone else who has recently been making money. Every three or four years they deliver a one-in-a-hundred-year flood. They are generally run for rich people in Geneva, Switzerland, by rich people in Greenwich, Connecticut. – Cliff Asness

Behavioral economists have provided us with many examples of anomalies in investor behavior, such as a preference for investments with lottery-like distribution despite their very poor historical returns. But the greatest anomaly is that despite decades of poor performance and the failure to effectively hedge exposure to conventional security classes, assets under management among hedge funds have grown from about $300 billion 25 years ago to about $5 trillion today.

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Myth Busters: Do International Stocks (Still) Make Sense for Long-Term Investors?

After years of U.S. stocks besting international markets (and more of the same so far in 2022), investing internationally seems to have a bad rap among many U.S. investors. We explore and debunk three “myths” to show why we think international stocks should hold a place in most long-term portfolios.

Myth #1: Global diversification doesn't work anymore. 

It’s no secret that U.S. stocks have had the upper hand on international markets for years —since around the start of the prior decade. To date, 2022 has been no different. The combined effect of U.S. stocks’ better performance and the strength of the US dollar drove the disappointing performance of international stocks. After what might feel like a very long period of U.S. market dominance, it’s fair for investors to wonder why they should bother investing both at home and abroad. To illustrate the value of global diversification at work, in Figure 1, we present rolling three-year returns for U.S., non-U.S. (developed and emerging), and global stocks from December 1990 through October 2022.

The dotted line represents global stocks. Whether U.S. or non-U.S. stocks have outperformed over any period, global stocks are always somewhere in the middle —neither the highest nor the lowest. This highlights the benefit of diversification for those that invest across global markets. Investors may avoid some potential downside in exchange for giving up some potential upside.

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Aging and Financial Decision Making: What Changes and What Stays the Same?

By Hal Hershfield

In my first faculty job at NYU, I taught an Intro Marketing class to a few sections of undergrads. Even though I was about 12 years older than the students, I still felt quite young – I was only 32, after all! Plus, it seemed like my students and I were more or less on the same page … that is, right up until I had one of my first office hours appointments. As I was writing some emails and listening to a Spotify playlist, a student walked in and suddenly exclaimed, “Wow, this is not the same sort of music that my parents listen to!”

“Obviously, it’s not the same music,” I thought, “her parents are probably about 20 years older than me; there’s no way she can think I’m that old.” But of course, that’s exactly what she thought.

Shortly thereafter marked the first time I looked in the mirror and asked myself, “Am I … getting old?”

It was also the first time that I started thinking earnestly, not just about my age but about how my age might affect my choices, especially my financial ones (I’m a business school professor, after all).

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Crypto is Money Without a Purpose

It isn’t a financial service and shouldn’t be regulated as one. Laws on gambling are more relevant.

By Todd H. Baker

Before FTX crashed, crypto lobbyists and many politicians were complaining loudly that crypto trading was being unfairly denied full participation in banking and finance by overly cautious regulators. We should thank our lucky stars that somebody showed good sense.

Granted, crypto trading looks a lot like the forms of finance we’re all familiar with. It’s made up of things called “exchanges,” “brokers,” “lenders,” “deposits” and “hedge funds.” The financial press breathlessly reports their every move. Crypto also carries the special mystique of the blockchain, which has let traders treat critics as anti-innovation Luddites.

Yet in the most crucial respect, the crypto marketplace isn’t at all like traditional finance. Finance and financial services exist for a purpose that crypto trading lacks. As a Nobel Prize-winning economist Robert Shiller once wrote, “Finance is not about making money per se . . .it exists to support other goals—those of society.”

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