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.
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.
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.