The Opportunity Cost of Holding a “Naïve” Portfolio

Abstract

The paper explores the effect of “naïve” portfolio strategies on investors’welfare. A “naïve” portfolio as a sub-optimal investment strategy produces sub-optimalasset allocations that result in investors’ welfare losses. To measure those losses I comparesub-optimal portfolios with optimal portfolios using the proportionate opportunity costwith various CRRA utility functions. A vector autoregression is used to generate the jointdistribution of asset returns. I show that the opportunity cost of investing in “naïve”portfolios does not exceed 16.7% while investing in the optimal number of asset and doesnot exceed 20.4% while investing in a sub-optimal number of assets. (G11)