Portfolio Concentration and the Performance of Individual Investors

Abstract

This paper tests whether information advantages can help explain why some individual investors concentrate their portfolios in only a few stocks. Using data on individuals' investments through a discount broker from 1991 to 1996, we find that the stock investments made by households that choose to concentrate their brokerage accounts in a few stocks outperform those made by households with more diversified accounts (especially among those with large portfolios). The excess returns of concentrated relative to diversified portfolios are stronger for stocks not included in the S&P 500 index and local stocks, potentially reflecting concentrated investors' successful exploitation of information asymmetries. Further, controlling for households' average investment abilities, a household's trades perform better when its portfolio includes fewer stocks. Total risks of concentrated household stock portfolios are larger and their Sharpe ratios are lower. However, because direct stock investments are only a small fraction of a typical concentrated stockowner's total net worth, concentrated stock holdings may improve the overall mean-variance tradeoff for some households.

Keywords: Portfolio Diversification; Information Asymmetry; Return to Concentration

JEL Classification: G11, G14