Everyone could use a few tips on becoming a better investor. Here's one: Invest like a child.
An academic paper (a big tip of the hat to Abnormal Returns) by Henk Berkman, at the University of Auckland Business School, Paul Koch, at the University of Kansas School of Business, and Joakim Westerholm, at Sydney University School of Business, looked at investment accounts for children aged 0 through 10 and discovered something quite remarkable: The accounts did very well, outperforming the accounts of older investors.
For example, in the day following a trade, children's accounts outperformed older investors by 9 basis points – which is big for a single day.
This is screaming for an explanation, of course. I would have thought that the adult guardians who oversee their children's accounts take a different approach than they take with their own money. For their kids, they think longer-term, since the money is generally used to fund education – particularly if we're talking about Canadian registered education savings plans – at least a decade down the road.
It seems to me that guardians would be less likely to actively trade stocks within the accounts, to their detriment. As Terrance Odean and Brad Barber argued in 2001, excessive trading was a sign of overconfidence, particularly by men, who generally underperform buy-and-hold women in the stock market.
But Mr. Berkman, Mr. Koch and Mr. Westerholm offer a different take, using data from the Nasdaq OMX Helsinki exchange. For one thing, they believe that the adults who open accounts for their children and invest on their behalf tend to be better investors, with more wealth and superior stock-picking skills.
"The emerging picture points to a broader group of informed guardians who tend to channel their best ideas through the accounts of children," they said in their paper.
Not convinced? I don't think the academics are either. So they offer another, more sinister, explanation: Children's accounts are ideal places for adults to hide illegal insider trading activity.
For sure, there are some unusual things going on here. The tykes do suspiciously well with trades conducted just before major corporate news events. The day before an earnings announcement, account holders get the share price direction right 57 per cent of the time. The day before a big share price shift, they get the direction right 58 per cent of the time.
And, here's the kicker: The day before a takeover announcement, they get the direction right 72 per cent of the time.
"Since this outperformance is especially evident for short horizons, it likely stems from superior private information that is about to become public," the academics said.
In other words, naughty children.