Your personality can hugely impact your investments

Numerous studies paint a rich picture of how individual traits impact financial decisions. Sometimes these decisions support good outcomes. But often they lead to mistakes and biases that can harm your wealth in the short- or long term, especially if you don't take professional advice.

Let’s delve into the latest research on investor personalities and see how they impact your decisions.

Is the 'investment personality' real?

Yes it is. Studies of twins have identified heritable traits that affect financial behaviour. For example, one analysis found that genetic factors account for 20 to 30 percent of the variation in people’s risk tolerance. This can impact decisions by making some people choose less risky assets in portfolios, avoid complex choices, and take fewer investment decisions.

That’s just the heritable traits. Research shows that the investment personality is also affected by cognitive abilities, life events, age, intelligence, wealth, income, skills, knowledge, and external influences.

But this is not merely 'nice to know'. Behavioural finance scientist Hersh Shefrin of Santa Clara University explains: "Personality characteristics, along with attributes such as age and income, are key determinants of sensible and actual investment behaviour. The key concept to understand is how much you relate emotionally to the act and experience of investing, especially being fearful, hopeful, and needing to feel like a winner."

Insight into these emotional tendencies, alongside a holistic overview of your financial situation, will help investment advisor ensure you get the best possible outcomes. For example, they can guide you away from biases and mistakes, and set up an optimal long-term portfolio for your needs - and your peace of mind.

Is risk aversion a problem?

Two key personality concepts are risk aversion and conscientiousness. Risk aversion, a very common trait across populations, means preferring less risky investment options even when higher-risk choices offer higher expected returns, especially over the long term. It's one of the most powerful influences on financial choices. Researchers have found that investors are ten times more likely to base decisions on subjective risk preferences than on objective measures of returns and volatility.

Gordon Clark, Emeritus Professor at Oxford University, notes: "Many people are so risk averse it becomes self-defeating. A more deliberate approach would allow them to get more involved in riskier assets such as equities, which provide much better returns long term.

"Being conscious of your own predispositions or prejudices can help. For example, it can help you see past an apparent immediate threat or opportunity to focus on better long-term opportunities. However, not all people are risk averse. Others can be overconfident and embrace risk where they should be more calculated. In both cases, people’s judgment needs recalibrating with expert advice."

A good example of risk aversion is 'premature preservation' - moving out of riskier assets too early in life, say in your 50s, and missing valuable investment returns in the following decades.

"Over-caution can be self-defeating, even in your 60s, when you still have 23 years to live on average," says Clark. "That’s not to mention what you leave your surviving relatives."

Wealth and conscientiousness

Meir Statman and Carrie Pan of Santa Clara University explored the trait of conscientiousness and found it is associated with relatively low risk tolerance. Statman explains: "This is important because people who have accumulated substantial assets tend to be highly conscientious, associated with self-control. This helped them save when young. But they have a terrible time letting go of conscientiousness when older, so live like misers.

"Financial advisors find it difficult to get their clients off their old good habits that turn bad. So when they die, many conscientious people are the richest in their cemeteries. They should learn it is better to give with a warm hand than a cold one."

Which type are you?

To understand your investment personality, it can help to look at how the four main types link to decision-making.

• Cautious investors base decisions on feelings - primarily fear - and are sensitive to losses. They struggle to make proactive investment decisions and have low trust in advice. Their portfolios include mostly safe investments. They should speak to advisors about how much risk they actually need and can tolerate long term.
• Methodical investors follow a disciplined investment strategy, basing decisions on hard facts, but tending to nitpick about small details. They rely heavily on research, not emotion. But they may also have low risk tolerance.
• Individualists make decisions based on hard facts and do not second-guess them. They think independently, trust their investment research, and are usually less risk averse than others.
• Spontaneous investors make frequent decisions based on feelings. They often second-guess themselves and chase investment fads. They also change their portfolios often and may include riskier investments. To avoid fads and impulsive mistakes, help from their advisor is crucial.

It's important to combine an understanding of the type of investor you are with knowledge of your ability to take risks, based on factors like how much wealth you have, and when you plan to use it. If your willingness to take risk is very different from your ability to do so, you  may well need further advice and education to bridge the gap.

The above is just one personality model, and academics are constantly developing new ones. For example, in 2023, the National Bureau of Economic Research identified links between investment decisions and the Big Five personality dimensions: extraversion, agreeableness, openness, conscientiousness and neuroticism.

Neuroticism, which reflects a person’s emotional stability, has a particularly strong effect, making individuals more pessimistic about stock returns and market crashes. These people also tend towards hypervigilance in checking portfolios frequently - known as the Meerkat Effect.

A deeper understanding

Understanding personality is not about 'uncovering' a fixed personality type, but about gradually gaining self-awareness. The idea is to stand back and observe your emotional responses to personal and external financial events before acting. If you make mistakes, it's worth thinking about the role of your personality and what you can learn. You can also learn from good decisions, but should be wary of overconfidence.

Personality is ingrained, so countering any adverse effects requires practice. The help of your relationship manager is essential, as they will get to know your personality traits, combine this with a holistic view of your circumstances, and help you set a strategy and navigate towards the best outcomes.