How your personality type dictates your investing style
When it comes to your money personality, you probably haven’t thought much beyond whether you’re a spender or a saver. But our inherent traits can influence our financial life in more ways than we might expect.
Every investor is different, with different financial goals, different tolerances to risk, different personal situations and different desires. From the point of view of investment management, these characteristics are often defined more rigorously as objectives and constraints. Objectives being the type of return being sought, while constraints include factors such as time horizon, liquidity levels, personal tax situations and risk level.
Over the last few years behavioural finance psychologists have discovered that investors appear to fall into 'types', and that knowing what 'type' of investor we are can feed into improved investment gains. The research of Bielard, Biehl and Kaiser (BB&K) identified five investor personalities that they labelled as Guardians, Celebrities, Individualists, Adventurers and Straight Arrows. Probably one of the most sophisticated models in use, the BB&K approach stresses the level of confidence an investor has and their preferred method of action - the way we respond.
As the name suggests, Guardians emphasis financial security and preserving the wealth they have worked hard to accumulate, rather than taking risks to grow it further. They also take loss very seriously. Guardians will often obsess over short-term performance – both positive and negative – and tend to worry about losing what they have gained previously. This can lead them to holding onto failing investments, with Guardians often suffering from loss aversion bias. Instead, they prefer to avoid making decisions and sticking to the status quo.
Older investors often demonstrate Guardian behaviours, and for many obvious reasons. As we age, the certainty of cash flow becomes paramount, and with it a focus on financial security.
Sorry to say, but celebrities often lack a serious interest in money or investing, or have little aptitude for either, so tend not to have a long-term plan or strategy. When it comes to investing their biggest fear is that of being left out and frequently regret not taking part in the latest investment fad – the Millennials call this ‘FOMO’ or ‘Fear of Missing Out’. But by the time they have heard of the latest investment fad, they usually end up investing at exactly the wrong time, when valuations are at their highest.
Unfortunately, they can also be prone to thinking they are more adept or talented than they really are at making investment decisions, which can lead to unwarranted risk seeking. Celebrities often suffer from self-attribution bias.
Like Celebrities, Individualists do not always have a long-term investment plan or strategy. However, they are very engaged in financial markets, have original investment ideas and like to get involved in the investment process. They are generally analytical, methodical and critical thinkers and will make their decisions based on logic, often attempting to learn as much as they can before they make an investment decision.
They have a higher risk tolerance, and understand that higher returns come with higher risks. But when their investments go down they don’t like to admit that they were wrong, or that they made a mistake.
Adventurers live for the thrill and excitement of making the right investment decisions. They are frequently successful in business and believe these are equivalent skill sets for financial related matters. They are often risk takers which can lead them to adjust their investment holdings frequently in response to short-term market conditions – this can be detrimental to long-term performance.
Adventurers are always on the look-out for the next big investment opportunity, and will tend to select investments based on how the opportunities they come across resonate with their personal values. Unfortunately, they can be overconfident in their abilities and can struggle with accepting some of the basic principles of investing such as diversification and asset allocation.
The personality profile of Straight Arrows is well balanced that cannot be placed at either end of the behavioural spectrum. Those with such a profile are average investors having a balanced composite of the other four investor types. Straight Arrows are willing to be exposed only to a medium level of risk.
What now for investing profiling, behavioural finance and our investing strategies?
At the start of this three-part series we set out to examine why it is that investors are not the rational, objective machines that traditional economic theory presumes. As we have discovered, the ways we process and respond to information influence our financial decisions, and the wider market.
These behavioural biases are ingrained aspects of our decision-making processes. Behavioural finance assumes there are no optimal decisions. Rather, decisions are impacted by mental shortcuts and subtle personal biases, which are influenced by our prior pattern of decisions and by the ever-changing contingencies of the decision context.
Personality typing can overgeneralise these decisions-making processes and the five profiles illustrated above are extreme caricatures. But, if we are honest, at least one of the above will resonate with each of us. Profiling can help us to become better investors by highlighting deficiencies in our investment style or how we are interacting with the market - for example, trading too frequently, selling too early, inability to cut losses, or a failure to use information effectively. Clearly, it’s not that black and white. But understanding how our natural tendencies drive us can help us understand our personal pitfalls as investors.
To be successful in the years ahead, it is critical that we identify our biases and find ways to minimise the negative effects. Good financial decisions require a combination of financial knowledge, self-knowledge, and the discipline to implement a plan dispassionately – and your financial adviser can help you to avoid the behavioural biases that might be impeding your financial decisions. Your financial adviser can help you understand how biases such as loss aversion works for instance. Sometimes simply understanding these concepts can help to reduce the impact of these biases on your ability to build wealth.
Your financial adviser can also help you develop investment portfolios that factor in your potential behavioural biases. As Adam Smith, widely considered as the father of modern economics once stated: “if you do not know who you are, the market is an expensive place to find out.” Investing in portfolios constructed in a systematic or quantitative manner will allow you to be protected from not only your biases but can even work to exploit the biases of other investors.
Important information and disclaimer
This article has been prepared by Godfrey Pembroke Limited ABN 23 002 336 254 AFSL 230690. Any advice provided is of a general nature only. It does not take into account your objectives, financial situation or needs. Please seek personal advice before making a decision about a financial product. Information in this article is current as at 4/02/2020. While care has been taken in the preparation of this article, no liability is accepted by Godfrey Pembroke Limited or its related entities, agents or employees for any loss arising from reliance on this article. Any opinions expressed constitute our views at the time of issue and are subject to change. Any tax information provided in this article is intended as a guide only. It is not intended to be a substitute for specialised tax advice. We recommend that you consult with a registered tax agent.