Search

In 4 experiments, undergraduates made hypothetical investment choices. In Experiment 1, participants paid more attention to the volatility of individual assets than to the volatility of aggregated portfolios. The results of Experiment 2 show that most participants diversified even when this increased risk because of covariation between the returns of individual assets. In Experiment 3, nearly half of those who seemingly attempted to minimize risk diversified even when this increased risk. These results indicate that novice investors neglect covariation when diversifying across investment alternatives. Experiment 4 established that naive diversification follows from motivation to minimize risk and showed that covariation neglect was not significantly reduced by informing participants about how covariation affects portfolio risk but was reduced by making participants systematically calculate aggregate returns for diversified portfolios. In order to counteract naive diversification, novice investors need to be better informed about the rationale underlying recommendations to diversify.

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.joep.2006.04.002 Byline: Ted Martin Hedesstrom, Henrik Svedsater, Tommy Garling Keywords: Premium pension; Heuristic choice rules; Internet-based survey Abstract: The results of previous analyses of citizens' actual choices of mutual funds in the Swedish compulsory public pension system were replicated in an Internet-based survey of fictitious choices among fund categories. The sample consisted of 392 university employees. Findings indicated a possible default bias, the use of a diversification heuristic, a home bias, and the use of a 1/n heuristic. Involvement in the fund choice, measured by self-rating scales, increased with the amount to invest but decreased with age. Involvement decreased the likelihood of choosing the default fund and was positively correlated with the number of funds included in a portfolio. Home bias and the use of a 1/n heuristic was however unaffected by involvement and by having previous stock market investment experience. Efforts to better inform investors about how to diversify are warranted. Author Affiliation: Goteborg University, Gothenburg, Sweden Article History: Received 8 July 2005; Revised 6 April 2006; Accepted 27 April 2006