Trading around divorce

Divorce is both stressful and common. Almost one in three Australian marriages will end in divorce. Of course, most of us don’t enter a marriage thinking it will end. Splitsville is not a planned destination on most people’s life course, unless you mean the bowling alley outside of Disney World.

Trading through divorce: a natural experiment

It is the temporary nature of divorce that presents an interesting natural experiment. While the explicit costs of divorce (legal fees, asset transfers, real estate transactions, and ongoing support) are well-documented, what is less understood is the impact of divorce on stock market trading decisions made by individuals. Up until now, data limitations have restricted the ability for researchers to examine this question. While data sets on individual trading records exist, it has been difficult to identify people who experience a marital breakdown (and the date they officially divorced).

Fortunately, data from Finland allows us to examine the trading records of individuals during the period around a court-ordered separation. As in many Scandinavian countries, the clearinghouse and court system both record the traders’ social security numbers. Matching the sources together allows us to see the trading performance of individuals before and after divorce.

The process of divorce entails an upheaval of many aspects of an individual’s life. If the stress of divorce negatively influences decision-making capabilities of the average trader, then it is plausible that their trading performance suffers during the most stressful time. After all, distractions from sporting losses, bad weather, flu season, and daylight savings, among other things, have been shown to influence trading behaviour. Prior research shows that people experiencing other forms of stress, including physical and mental health issues, appear to avoid making active decisions and take fewer risks. It is, of course, rather more difficult to observe ‘how stressed’ a particular person was at the time of their trading decision (as opposed to laboratory tests, where literal ice buckets can be employed).

In our study, recently published in the Journal of Banking and Finance, we estimate the impact of divorce on individual-investor trading performance. We examine the stock-market trading profits of individuals who experienced a divorce, comparing their returns in the period one-to-three years prior to settlement (pre-divorce), with a period one year either side of the divorce settlement (when stress is expected to be highest). On average, trades made during the period surrounding divorce earn 3% per annum less than those in the pre-divorce period. Investors with smaller portfolios and those who trade infrequently tend to suffer even more (losing 10% per annum or even more).

The bad trading performance when offloading shares post-divorce might reflect some ‘liquidity needs’ for the trader, selling stocks indiscriminately (or at the wrong time) to fund the furnishings of that post-divorce bachelor pad. However, the evidence also shows that divorcing traders also perform poorly on the stocks they decide to purchase. While liquidation needs may explain part of the poor performance on sell transactions, the poor performance on buys is more likely to be due to stress, as buying requires a conscious decision on the part of a trader.

Online brokers – a divorcee’s best friend

How can one mitigate the destructive effects of poor post-divorce trading decisions? The answer may be to find solace in the arms of the online broker. Investors who are active traders suffer less from the post-divorce haze. Being able to pay attention to your share portfolio is not necessarily a luxury afforded to every divorcee, but is probably indicative of someone facing less stress. The economic rationale is that paying close attention to the market helps the divorcee to select the right stocks to trade.

Divorce, for most, is an uncomfortable, life-altering experience. It is one of the greatest financial risks faced by high net-worth individuals. Unlike many other risks, it cannot be easily diversified, and remains uninsurable (though one can imagine signing that paperwork). People who attempt to skirt the financial consequences of divorce are finding it ever-more difficult. Pre-nuptial (binding financial) agreements are rare in Australia but may offer some piece of mind.

Moreover, attempts to hide assets from the family courts are being cracked down upon. The Australian Taxation Office (ATO) has recently gained new powers (under the Visibility of Superannuation law) to disclose super holdings to the family court.

The ensuing effect of divorce on decision-making can be unpredictable. It is at this most-challenging time that investors could benefit greatly from financial advice, especially on the path to retirement. Clear heads in the realm of trading could prevent an already-difficult situation from being made worse.

Image: Maxim Hopman