Understanding the Disposition Effect in Active Equity Investing

Easy Active Equity Investing Behavioral Considerations

As an equity portfolio manager, you have observed that investors often make irrational decisions influenced by their emotions and cognitive biases. Understanding these behavioral considerations is crucial for enhancing investment strategies. One common bias is the disposition effect, where investors tend to hold losing investments too long while selling winning investments too early. This behavior can impact the overall performance of an equity portfolio.

Given this context, which of the following statements best encapsulates the implications of the disposition effect on active equity investing?

The disposition effect leads to a more diversified portfolio since investors are likely to sell winners quickly.

The disposition effect can result in suboptimal portfolio performance due to prolonged holding of underperforming assets.

Investors displaying the disposition effect are likely to outperform the market by strategically timing their trades.

Hint

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