Naïve diversification in investment decisions

• Behavioural studies of portfolio diversification typically deal with how people di-vide investments between risky and riskless assets. However, effective diversifi-cation also requires that the returns of the risky assets included in a portfolio do not covary excessively. In two experiments undergraduates made hypothetical investment choices. In Experiment 1 participants paid more attention to the vola-tility of the individual assets than to the volatility of the aggregated portfolio. In Experiment 2 most participants diversified even when this in fact increased risk due to covariation between the returns of the individual assets. The results sug-gest that novice investors neglect covariation when diversifying across invest-ment alternatives.

Nyckelord

Diversification heuristic

covariation neglect

novice investors

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