On average, retail investors aren’t the smart money in the market. They tend to trade on noise and in some cases, they may trade against fundamental information, creating systematic market mispricing and opportunities for ‘smarter’ investors. One such systematic opportunity that is made worse by retail investors seems to be the post earnings announcement drift. A
Stock prices are set by the last marginal seller or buyer; 2% of stocks trade each day, but the other 98% mark their portfolios to market based on the last trade. It might be interesting to somehow adjust for differences in holding periods.
I would guess that retail investors tend to hold longer. I remember someone once joking after a stock he held went down a lot "well, that 'trade' just turned into an 'investment'!". I also know from personal experience that sometimes retail trades are delayed in order to turn the capital gain or loss from short-term to long-term (in the US the latter is taxed at a much lower rate than the former), or apply tax loss carry-forwards. If a US retail investor has a $100 short-term gain, and a 45% marginal income tax bracket, if he sells right away his after-tax profit is $55. If he waits until he's held it for a year, his long-term capital gains rate is 15%, so his after-tax profit is $85. If he has a long-term tax loss carry-forward from a previous loss of $100, and applies this toward the gain, his after-tax profit is $100. I've often heard people say "I'd love to take profitsin this name, but I need to find a loser to sell first so I have an offsetting tax loss". Warren Buffett once said something along the lines of "never make any investment decision based upon tax considerations, only fundamentals", but people routinely ignore that ... including himself when it came to Apple stock.
In Germany, all interest, dividends, and capital gains are taxed at a flat 25%, so I wonder if retail traders there would show more favorable results. I was in institutional investment for almost 40 years, and never *once* heard anyone care at all about tax considerations, which might explain why they may appear more adroit by comparison. I don't necessarily think they're collectively much smarter ;-)
Indeed. I have another post coming up where I show that retail investors do indeed in average hold on to stocks somewhat longer than institutions, but the gap isn’t very large. It’s more a matter of weeks not months or years.
And yes, tax considerations are a particularly American obsession. Tax loss harvesting and other “tax-optimised” strategies only exist as a product in the US and a very few other countries. The rest of the world simply doesn’t put that much emphasis on it or, as is the case in Germany and other jurisdictions, don’t face these weird differences in tax rates between short-term and long-term holdings.
Stock prices are set by the last marginal seller or buyer; 2% of stocks trade each day, but the other 98% mark their portfolios to market based on the last trade. It might be interesting to somehow adjust for differences in holding periods.
I would guess that retail investors tend to hold longer. I remember someone once joking after a stock he held went down a lot "well, that 'trade' just turned into an 'investment'!". I also know from personal experience that sometimes retail trades are delayed in order to turn the capital gain or loss from short-term to long-term (in the US the latter is taxed at a much lower rate than the former), or apply tax loss carry-forwards. If a US retail investor has a $100 short-term gain, and a 45% marginal income tax bracket, if he sells right away his after-tax profit is $55. If he waits until he's held it for a year, his long-term capital gains rate is 15%, so his after-tax profit is $85. If he has a long-term tax loss carry-forward from a previous loss of $100, and applies this toward the gain, his after-tax profit is $100. I've often heard people say "I'd love to take profitsin this name, but I need to find a loser to sell first so I have an offsetting tax loss". Warren Buffett once said something along the lines of "never make any investment decision based upon tax considerations, only fundamentals", but people routinely ignore that ... including himself when it came to Apple stock.
In Germany, all interest, dividends, and capital gains are taxed at a flat 25%, so I wonder if retail traders there would show more favorable results. I was in institutional investment for almost 40 years, and never *once* heard anyone care at all about tax considerations, which might explain why they may appear more adroit by comparison. I don't necessarily think they're collectively much smarter ;-)
Indeed. I have another post coming up where I show that retail investors do indeed in average hold on to stocks somewhat longer than institutions, but the gap isn’t very large. It’s more a matter of weeks not months or years.
And yes, tax considerations are a particularly American obsession. Tax loss harvesting and other “tax-optimised” strategies only exist as a product in the US and a very few other countries. The rest of the world simply doesn’t put that much emphasis on it or, as is the case in Germany and other jurisdictions, don’t face these weird differences in tax rates between short-term and long-term holdings.
This last graph “Level of institutional ownership and post earnings announcement drift” suggests the following:
- Either institutional investors pick “better” stocks than retail investors, leading to higher returns,
- Or(/and) retail investors react much slower than institutional investors to earnings surprises.
I think it’s a bit of both, but I can’t separate the two.