Is Your Personality Impacting Your Portfolio?
Research suggests certain personality traits can influence a range of investment decisions and outcomes.
If you invest regularly you've probably made investment mistakes. Maybe you sold a winning stock too early or held on to a losing stock too long. Mistakes are common in investing, and here at Morningstar we've worked hard to help you avoid them. However, there are mistakes that seem to haunt all of us, the ones where we went against our advisor or followed our gut to no avail.
Mark Smeez, 33, from Hamilton, Ont., knows this all too well. He says that during the 2008 crash he sold all of his stocks and mutual funds. "I didn't have an advisor, but I did have assistance from someone in the financial industry and they told me that the storm would pass."
The confidant told Smeez to hold on to his assets. Unfortunately, he did the opposite and lost about $7,500 in the process. "I don't know why I didn't listen. I was worried and I was afraid of losing money."
Robert Durand, professor of finance at Curtin University in Australia, attributes these decisions to personality traits.
Durand and two colleagues concluded in a Journal of Behavioral Finance article that personality traits are associated with a wide range of investment decisions and outcomes. The research for that article and Durand's ongoing research is based on the five-factor model of personality traits, which is the leading paradigm in personality research.
It's an efficient model because it dismisses hundreds of personality traits in favor of the "Big Five," which are listed below along with some advantages and disadvantages they bring for investors:
Extraverts are social, enthusiastic, talkative, and assertive. In general, they tend to take on more risk in order to fulfill their need for excitement.
Advantage: They tend to have a higher risk tolerance, which can mean potentially higher returns.
Disadvantage: They may take on too much risk and lose money.
Those high in agreeableness are trusting, altruistic, and optimistic. They need to get along with other individuals.
Advantage: They are cooperative when working with advisors on their portfolios.
Disadvantage: They do not like to offend others and may be hesitant to raise any red flags that they see.
Conscientious persons are thorough, careful, and diligent. They have the ability to delay immediate gratification in favor of long-term goals.
Advantage: Long-term investors can be patient and restrain themselves from impulsive risk-taking.
Disadvantage: They are too risk-averse.
Neurotic individuals are emotionally unstable. They are prone to psychological distress including depression, anxiety, and anger.
Advantage: They are drawn to risk because of its emotional appeal, and similar to the extravert advantage, higher risk tolerance can potentially equal higher returns.
Disadvantage: They are impulsive; therefore, they are prone to making emotional financial decisions.
Openness to Experience/Intellect
Individuals who are open to experience are imaginative, curious, and receptive to new ideas. They actively seek new experiences. This trait is highly correlated to intelligence. There is no advantage or disadvantage listed because openness to experience/intellect is the least studied of all the traits.
Durand says personality traits are remarkably stable once you reach age 30. Therefore, if you determine your personality traits early on in your investing career and understand how they'll affect your decision-making, then you should be able to avoid some mistakes.
For a complete personality diagnosis, Durand suggests seeing a professional who can properly administer the test. However, to obtain a rough idea of your personality, you can complete this online test. Durand is not associated with this website. It is administered by Dr. Tom Buchanan, department of psychology at University of Westminster, U.K., who is collecting data for online research.
There are 41 personality questions in the test. Once you've completed it, your scores are ranked into three categories for each of the Big Five. The categories are: "relatively low," meaning you are in the bottom 30%, "relatively high," meaning you score in the top 30%, and "about average," meaning you are somewhere in the middle.
For example, I scored relatively high in extraversion. According to the test: "This trait reveals preference for, and behavior in, social situations. People high in extraversion are energetic and seek out the company of others. Low scorers (introverts) tend to be more quiet and reserved. Compared to others who have taken this test, your score on this dimension (39) is relatively high."
In fact, Durand says that two of the five factors, neuroticism and extraversion, seem to play a larger role compared to the other traits.
He says investors scoring highly in neuroticism are attracted to risk, but they seem to find it disturbing. They want to do something about it, but seem incapable of doing so; they will sell risky stocks only to buy others.
Higher extraversion scores are associated with higher returns, even after adjusting for risk. Durand says, "Extraverts are attracted to higher risk, but they manage it better, getting higher returns for higher risk, which should be the case according to standard finance theory."
The idea for this article is derived from the chapter "Personality Traits" by Lucia Fung and Robert Durand pages 99-115 in the textbook "Investor Behavior The Psychology of Financial Planning and Investing" by H. Kent Baker and Victor Ricciardi.