Who Invests in Stocks? Stock Market Participation

It’s generally accepted that people aren’t equally invested in the stock markets. It’s usually accepted that higher income individuals have a higher percentage of their net worth in stocks than lower income individuals. Did you know that stock market participation also varies by state? The Federal Reserve Bank of St. Louis published a paper showing how participation varies widely around the country and attempts to identify some patterns.

Given the high return of stocks, it is puzzling that many households do not participate in the stock market and, hence, forgo the high return. In addition, the nonparticipation behavior is at odds with modern portfolio theory. The theory implies that all households should invest at least a fraction of their wealth in stocks in order to take advantage of the equity premium. However, the data show that many households do not participate in financial markets.

The inability of modern portfolio theory to explain what is observed in the data leads to a “participation puzzle.” A common explanation of this puzzle is the individual participation cost, which includes both monetary and nonmonetary costs. The monetary costs are relatively straightforward, including transaction or brokerage fees. The nonmonetary costs are broadly defined to be the cognitive and time costs of understanding the investment object or processing previous experiences with stock markets. The participation cost, especially the nonmonetary costs, could vary widely across the population.