Household Investment - The Horizon Effect

Abstract

Individuals tend to simplify a complex portfolio decision problem into several manageable dimensions, each of which can frame their perception of risk in a certain way. We check this view by studying the effect of investment horizon on households' portfolio decisions. Using the Federal Reserve Board's Survey of Consumer Finances (SCF) data, we find that households allocate more of their wealth in stocks if they report longer planning horizons, and we find that the existence of foreseeable expenditure significantly change the dependence of risky stock investment on the planning horizon. We decompose the reported planning horizon into an objective part and a subjective mental accounting part, and find that the mental accounting part has a greater effect on household portfolio choice. This is consistent with the argument that individuals make investment decision based on the horizon at which the risk is perceived rather than the horizon at which the investment is made.