Education and avoidable costs in the stock market

This study investigates preventable financial mistakes by retail investors in the stock market and whether education helps reduce their likelihood.

The paper examines the change in brokers’ commission schedules in the aftermath of the acquisition of Bolsa de Valores de Lisboa e Porto, the Portuguese stock market, by Euronext Group. The acquisition led to significant changes in the structure of brokers’ trading fee schedules penalizing small transactions, which were very common among retail investors prior to the acquisition. This event allows the authors to assess the ability of different groups of investors to adjust their trading behavior the new trading fees. More specifically, the paper gauges whether those investors displaying higher education and math skills modified their trading behavior faster and more effectively, thereby avoiding excessive fees.

Not surprisingly, the paper finds that retail investors with university education, financial knowledge, and math skills were able to avoid excessive trading fees, while other retail investors failed to adjust their trading behavior and, as a result, paid higher fees.

The paper also finds that past trading experience helps enhance the performance of those lacking education. Differences in the adjustment to the new fees become narrow when considering highly experienced individuals. One interpretation is that trading experience constitutes an imperfect substitute for education.

The paper concludes that the change in trading patterns was the most prominent driver of the difference in excess transaction fees charged to individuals displaying higher levels of education and other individuals. Indeed, considering only individuals with a similar propensity to post small trades, those with a university degree were faster to scale up order size.

Overall, the paper documents failure by many retail investors to effectively adjust their trading behavior. The disclosure of information is essential but not sufficient to avoid investor mistakes.

Click here to go to the paper by Paulo Pereira da Silva and Victor Mendes.