Why Do People Not Participate in Markets?

Lots of people participate in markets – an estimated 62% of US adults (individual stocks, mutual funds, retirement accounts, etc.).

But many people participate, but don’t participate in them in the way that fits their natural preferences.

A recent paper – What Drives Investors’ Portfolio Choices? Separating Risk Preferences from Frictions – looked at this exact issue.

The crux is that a lot of people don’t invest in the stock market, even though stocks usually earn more money over time than being in something entirely risk-averse like interest-bearing cash.

Economists have wondered why.

There are two main possibilities:

1. People are very afraid of risk, so they truly prefer safer investments.
   
2. People actually like stocks, but it’s a hassle to sign up, choose investments, and make changes. So they just stick with whatever is set up for them.
   

This paper tries to figure out which explanation is correct.

We’ll look through it.

Key Takeaways – Why Do People Not Participate in Markets?

• Researchers studied 401(k) plans where employers changed the default investment option.
• Some workers were automatically put into safe funds, others into stock-heavy funds.
• If people truly hated risk, they would leave stocks when defaulted into them.
  • Instead, over 90% stayed invested in stocks when auto-enrolled.
• Many who were defaulted into safe funds slowly moved into stocks (given that’s most people’s natural preference given the equity risk premium over time).
• Conclusion: Most people actually prefer stocks.
• Low stock participation is mainly due to inertia and small hassles, not extreme fear of risk.

The Key Idea

Many workers have a 401(k) retirement account through their job.

When you start a job, your employer often picks a “default” investment for you.

That means if you do nothing, your money automatically goes into that option.

Some companies set the default to:

• A very safe option (like a money market fund).
  
• A stock-heavy option (like a target-date fund).
  

The researchers compare workers who were hired before and after companies changed their default.

This creates a natural experiment:

• If you’re defaulted into stocks and you really hate risk, you should quickly move your money into something safer.
  
• If you’re defaulted into something safe but actually like stocks, you should actively move into stocks.
  

What they found

When people were automatically put into stock-heavy investments:

• More than 90% stayed invested in stocks.
  

When people were automatically put into safe investments:

• Many eventually moved into stocks, but slowly.
  

This tells us something important:

Most people do want to own stocks, but they don’t always take the steps to get there if the default is safe.

What does that mean?

The researchers estimate that:

• About 94% of people would choose to invest in stocks if there were no hassles.
  
• The amount of stock people prefer goes down as they get older (which makes sense, because older people are closer to retirement).
  
• People are moderately risk-averse, not extremely afraid of risk.
  

So the main reason people don’t invest in stocks isn’t that they’re terrified of risk.

It’s that:

• It takes effort – and often knowledge – to change your investments.
  
• People procrastinate.
  
• They stick with whatever is automatically chosen.
  

Big Takeaway

Low stock market participation isn’t mostly about fear.

It’s mostly about inertia and small frictions — meaning tiny costs, effort, or mental barriers that stop people from acting on what they actually prefer.

In other words:

Most people want stocks.

They just don’t always bother to switch into them unless the system nudges them there.