Research shows being in the news attracts investors

by Dan Sondhelm

We recently came across a research project conducted at the University of California entitled “All that Glitters: the Effect of Attention and News on the Buying Behavior of Individual and Institutional Investors.” The study looked into how investors choose the stocks that they buy and sell.

At the guts of the study, and of most interest to us, was their hypothesis (and conclusion) that individual investors only consider purchasing stocks that have first caught their attention – which they defined as stocks that had been in the news, stocks that had experienced high abnormal trading volume or stocks that had experienced extreme prior one-day returns.

The researchers concluded that even though there are thousands of stocks available, investors select the ones they invest in from a much smaller universe – only those that they “noticed.” From that smaller, more manageable group, they apply their preferences in deciding which to buy. Of course, they don’t buy all the stocks that catch their attention; however, for the most part, they only buy stocks that do.

In fact, when Maria Bartiromo mentioned a stock during CNBC’s Midday Call, researchers in a related study in 2002 measured a fivefold increase, on average, in stock volume in the minutes that followed.

While we are not in a position to repeat these studies, we believe the individual investors will behave the same way when selecting mutual funds to invest in.

Here’s what the research found:

• Individual investors face a formidable search problem, there are thousands of common stocks, and human attention is limited. So, they look for ways to limit the number from which to choose, tending to choose only from those that catch their attention as defined above.

• Whether contrarian or trend-follower, an investor is less likely to purchase a stock that is out of the limelight.

• Individual investor’s selling behavior is linked to past returns of the stocks they sell (regardless of future projections even though buying behavior is linked to future returns).

• As we would hope, professional investors as a whole exhibited a lower tendency to buy on high attention days, basing their decisions on more specific, studied analysis.

So what’s the lesson for a mutual fund firms? Investors have an overwhelming number of investment options and limited resources of time and analytical tools to help them evaluate them all. The study results confirmed that individual investors, for the most part, make their investments from among a limited number of choices, those that catch their attention.

Are you using strategies to catch investors attention? Post your best practices in the comments section below.

For the study paper, see:

Barber, Brad M. and Odean, Terrance, All that Glitters: The Effect of Attention and News on the Buying Behavior of Individual and Institutional Investors (November 2006). EFA 2005 Moscow Meetings Paper.