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A 2025 study in the Journal of Financial Economics analyzed how nine categories of market participants trade against 193 return predictors, and the finding for retail investors was blunt: individuals systematically trade in the wrong direction. They buy the stocks the evidence predicts will underperform and sell the ones likely to outperform. The smart money (corporate buybacks and short sellers) sits on the right side, even hedge funds struggle on the long side, and the practical takeaway is simple: a low-cost index fund opts you out of a game most participants lose.
Key Takeaways
- Retail investors systematically trade the wrong way, buying future underperformers and selling outperformers.
- The smart money is buybacks and short sellers, who have the best information.
- Even hedge funds underperform on the long side; their edge is in shorting, not picking winners.
- A low-cost index fund removes the behavioral decisions that destroy value.
What Did the Study Find?
The research, “Taking Sides on Return Predictability” by McLean (Georgetown), Pontiff (Boston College), and Reilly (UT Dallas), built a forecasted-return measure from 193 academic stock predictors (valuation, momentum, profitability, growth, and more) and compared it to how each investor group actually traded. The participants sorted into clear groups:
- The smart money: corporations doing share buybacks and short sellers, both of whom traded in the predicted profitable direction. Companies know their own value better than anyone, and short sellers do deep fundamental research.
- The neutral money: institutional investors, including mutual funds, pensions, and even hedge funds’ long positions, showed no robust ability to position on the right side.
- The losing side: retail investors, who accumulate the stocks the evidence most predicts will underperform and cut the ones likely to outperform, so their aggregate trading predicts returns in the wrong direction.
Strikingly, the predictors worked most strongly exactly in the stocks where retail trading was most intense, meaning the more individuals pile into a stock, the more likely it is to underperform. High retail enthusiasm is, on average, a negative signal.
Why Does This Happen?
It is not malice, just predictable behavior. Individuals chase recent returns, buying what just went up and selling what just fell, so they buy high and sell low because recent performance is the most visible, emotional signal (a pattern Barber and Odean documented decades ago). They show the disposition effect, selling winners too early to lock in the good feeling and holding losers too long to avoid realizing a loss, the opposite of what evidence-based investing says. And they concentrate on high-profile, heavily discussed stocks (news names, recent IPOs, social-media trends), which already reflect the most optimism and have the least room to outperform.
Aren’t Hedge Funds the Answer?
No. One of the most striking findings is that hedge funds’ long positions were poorly positioned relative to the predictors, despite their research, models, and resources. Hedge funds are far better at short selling than at long investing, so their edge is in spotting stocks to short, not stocks to own. For anyone hoping to delegate stock-picking to a professional fund, that is sobering, and it fits decades of evidence that actively managed equity funds, on average, underperform their index after fees.
What Does Being on the Wrong Side Cost?
It compounds. Buying low-return stocks and selling high-return ones generates transaction costs on both sides, triggers capital gains taxes from selling winners early, and widens the return gap versus a diversified index over time. There are two separate costs: the behavioral cost of bad selection and the structural cost of higher fees on any active vehicle.
Use this calculator to see what fee differences alone do to a portfolio:
Investment Fee Impact Calculator
What Can You Replicate From the Smart Money?
One usable signal: pay attention to insider buying and corporate buybacks as evidence of management’s real conviction, since those buyers have the most complete information. But the broader, more actionable implication is simpler: the case for passive index investing is not just lower fees, it is opting out of a behavioral game the evidence shows most participants lose. An index fund does not chase performance, does not show a disposition effect, and does not get excited about trending stocks; it just holds the market and captures its return. See our guide on the best low-cost index funds.
What Is the Practical Implication?
The study does not say every individual always loses or that no one can pick stocks; a small minority show persistent skill. But as a group, retail investors trade in the direction that predicts losses, the stocks they buy underperform and the ones they sell outperform, across the broadest dataset ever assembled. For a younger investor who opened a zero-commission account drawn in by social-media stock talk, the answer to “will active stock-picking add value?” is, on average, no, it subtracts value versus a passive alternative. The fix is straightforward: low-cost, diversified index funds tracking broad benchmarks, which remove the value-destroying decisions and have beaten most active alternatives over long horizons. See our guide on how much to save for retirement.
Use this calculator to see how steady index investing compounds:
Compound Interest Calculator
FAQ
Why do most individual investors lose money in stocks?
Because they systematically trade the wrong way, buying stocks that go on to underperform and selling ones that outperform, driven by chasing recent returns, the disposition effect, and crowding into trending stocks.
Are professional fund managers better at picking stocks?
Not reliably on the long side. The study found even hedge funds struggle to position long portfolios well, and most active equity funds underperform their index after fees. Their edge, if any, is in short selling.
What should I invest in instead of picking stocks?
Low-cost, diversified index funds or ETFs tracking broad benchmarks. They remove the behavioral decisions that destroy value and have outperformed most active alternatives over long horizons.
Is buying trending or popular stocks a good idea?
Usually not. The study found returns are predicted to be worst exactly where retail trading is most intense, so heavy retail enthusiasm tends to be a negative signal for future performance.
Bottom Line
The most comprehensive 2025 study of market participation found retail investors systematically buy future losers and sell future winners, so the smart move is to stop picking and hold a low-cost index fund. You cannot reliably out-trade the market, and an index fund captures its return while removing the behavior that costs you. To go deeper, see our guides on the best low-cost index funds, how much to save for retirement, and Roth IRA vs 401(k).
This article summarizes academic research for general educational purposes and does not constitute investment advice. Past performance is not a guarantee of future results, and aggregate findings may not apply to every individual.
