Investment Mistakes of Individual Investors and the Impact of Financial Advice

Abstract

Extensive research has demonstrated and analyzed deviations in individual investors' investment decisions from recommendations of financial theory. As there is still no structured framework for evaluating investment mistakes, we introduce a generic investment process for individual investors as guiding structure. Going along this investment process we compare findings from existing research, contrasting normative recommendations with empirical evidence about actual behavior of individual investors. We show that these deviations lead to considerable welfare losses. Therefore we present financial advice as (potentially) correcting factor in this process and construct a simple model to capture its very impact on individual investors' investment success, measured in risk-adjusted return and wealth.

Keywords: Financial Advice, Behavioral Finance, Household Portfolios, Investment Behavior

JEL Classification: D14, G29