Too Many Cooks in The Kitchen

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Brad Barber and Terrance Odean of the Graduate School of Management, University of California at Davis, have done a series of studies on investor behavior and performance. The following summary discusses some of their studies and their main findings.

  • Individual investors on average underperform appropriate benchmarks.
  • Men versus women: though the stock selections of women do not outperform those of men, women produce higher net returns due to lower turnover (lower trading costs).
  • Frequent traders versus less active investors: individuals that traded the most (presumably due to misplaced confidence) produced the lowest net returns.
  • Individuals that switched from telephone trading with a discount broker to e-trading: individuals that switched to Internet trading (presumably due to either past success or overconfidence) performed worse after the switch (due to the costs of their increased turnover).

Odean and Barber’s latest study, “Too Many Cooks Spoil the Profit, Investment Club Performance,” appeared in the Financial Analysts' Journal. The study covered 166 investment clubs, using data from a large brokerage house, from February 1991 to January 1997. The following is a summary of their findings, which include all trading costs:

  • The average club tended to buy high beta (highly volatile) small-cap growth stocks.
  • The average club had turnover of 65%.
  • The average fund lagged a broad market index by 3% per annum, returning 14.1% versus 17.9%.
  • 60% of the clubs underperformed the market.
  • When performance was adjusted for exposure to the risk factors of size and value, alphas were negative even before transactions costs. After trading costs the alphas were negative 4.4% per annum.

While their findings are not surprising given all the evidence on the failure of active managers to beat their benchmarks, they do conflict with data from the 35,000 member NAIC (National Association of Investment Clubs). The study noted that several articles in the Wall Street Journal and New York Time claimed that NAIC surveys show that instead of 60% of the clubs underperforming, 60% outperform. There are three good possible explanations.

  • First, as with actively managed funds, there is likely to be survivorship bias in the dataclubs that perform poorly might break up.
  • Second, there is likely to be reporting bias in the dataclubs that perform poorly are less likely to report results than clubs that do well.
  • Third, there may be more Beardstown Ladies out there: clubs that simply miscalculate returns.

There were some other interesting findings:

  • Despite trading less than individuals (65% turnover as compared to 75% for individual investors), and therefore incurring lower trading expenses, clubs produced lower returns than individual investors, proving that at least when it comes to investing, fewer heads may be better.
  • The clubs would have been far better off if they never traded during the year: beginning of the year portfolios outperformed their actual holdings by 3.5% per annum. The reason was that the stocks they sold outperformed the stocks they bought by over 4% per annum. This is something that clubs have in common with individual investors - trading is hazardous to their financial health.


Besides being further evidence of both market efficiency and passive investing as the winning strategy, a conclusion that can be drawn from this study is that while an investment club may serve a useful social function, it is unlikely to prove to be a good investment vehicle.

Additional research papers by Odean:

"Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors"
"Do Investors Trade Too Much?"
"The Courage of Misguided Convictions: The Trading Behavior of Individual Investors"
"Volume, Volatility, Price, and Profit When All Traders Are Above Average"
"Are Investors Reluctant to Realize Their Losses?"
"The Internal Call Market: A Clean, Well-Lighted Place to Trade"

Larry Swedroe is the author of "The Only Guide To A Winning Investment Strategy You Will Ever Need." He is also the Director of Research for and a Principal of Buckingham Asset Management, Inc. in St. Louis, Missouri. However, his opinions and comments expressed within this column are his own, and may not accurately reflect those of Buckingham Asset Management.