Individual Investors Can Persistently Beat the Stock Market

Insider Monkey, your source for free insider trading data, knows individual investors consistently underperform the market on the average. This is true for the entire group of individual investors. However, it's possible that a small group of individual investors can persistently beat the stock market. A 2005 study by Coval, Hirshleifer, and Shumway documented strong persistence in the performance of individual investors. Investors that were in the top decile in terms of performance beat the investors that were in the bottom decile by about 8 percent per year. If markets are efficient and nobody has a shred of ability to predict future stock returns, then we wouldn’t have observed this phenomenon. Skeptics approach us with the accusation that our claim is a result of careful data mining. Or, they say, these returns are only possible on paper and not in an actual portfolio. The truth is, this study is robust to such criticisms. The authors didn't have to “pick” an investment strategy or employ screens. The returns used in this study were actual returns  of actual investors, and the prices paid by these investors also reflect the “market impact” of their actual trades. The only valid criticism this study deserves is that the data (individual transactions of tens of thousands of investors) aren't available publicly, so we can’t commercially implement a strategy based on these findings. But this doesn't change the fact that the efficient market hypothesis is proven wrong once again. And this phenomenon isn't limited to US stock markets either. Three Norwegian researchers, equipped with all the holdings and transactions of all individuals that are active in the Oslo stock market, found similar results. Portfolios of stocks that are favored by past top-performers generated between 72 and 125 basis points per month in abnormal returns. So some investors have the ability to consistently outperform their risk adjusted benchmarks. The key word here is “consistently”. When past performance is measured using Appraisal ratio (Jensen’s alpha divided by standard deviation of the individual’s portfolio), the top performers’ portfolio achieves an abnormal return of 73 basis points per month for 36 months. That’s more than 9% per year above index funds. Past performance can predict future performance for certain groups of traders, after all.
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