Down or Out: Assessing the Welfare Costs of Household Investment Mistakes

TLDR

The study examines how efficiently Swedish households invest, using detailed disaggregated data. The authors analyze inefficiencies arising from underdiversification and from households not participating in risky asset markets. Most Swedish households outperform the domestic stock index via international diversification, yet financially sophisticated investors trade more aggressively and suffer greater losses from underdiversification, while the return cost of nonparticipation is roughly half when considering that nonparticipants would likely be inefficient.

Abstract

This paper investigates the efficiency of household investment decisions using comprehensive disaggregated Swedish data. We consider two main sources of inefficiency: underdiversification (“down”) and nonparticipation in risky asset markets (“out”). While a few households are very poorly diversified, most Swedish households outperform the Sharpe ratio of their domestic stock index through international diversification. Financially sophisticated households invest more efficiently but also more aggressively, and overall they incur higher return losses from underdiversification. The return cost of nonparticipation is smaller by almost one‐half when we take account of the fact that nonparticipants would likely be inefficient investors.