How Does Personality Impact Investing Behavior?
My dad was a conservative man. To save money, he’d happily drink milk past the expiration date. He routinely unplugged unoccupied phone chargers. He kept the temperature a sweaty 79 degrees during the summer (we get almost 3 weeks of 100-degree weather in Texas) and practically no heat was turned on in the winter. He drove a used, 15-year-old Corolla (which he later sold to me). He definitely was one of those “turn the lights off when you leave the room” dads.
The thing is, my father wasn’t pressed for cash. He was a physician. I don’t know exactly how much he made, but the average salary in his industry is 160-260k a year—not exactly minimum wage.
He’d argue that frugality is how smart people build wealth. After all, Americans are frivolous with their money.
He wasn’t wrong.
Instead of spending on new cars, or unspoiled milk, my old man worked to become debt-free, purposely paying twice his mortgage and school loan payments each month. By his early 50s, he had absolutely no debt to his name. No car payment, no credit cards—nothing.
And naturally, his conservative personality matched his investing habits—meaning he resisted investing altogether. How could he subject his hard-earned income to the whims of an unpredictable market? (He often cited the 2008 market crash.)
But he did try it once.
He invested 10K into a startup called TV Guardian. Their product (hooked up to your cable box) would silence your TV during moments of swearing or obscenity and replace it with closed-captioned, reworded sentences that cleverly hid what the profane word was. In truth, it wasn’t that clever. For instance, it replaced F-bombs with “wow” so the sentence would read: “what the wow is going on here?!” No joke. That is real. Needless to say, there was no ROI; and his bias against investing was confirmed.
But it gets me thinking: do we base our money-decisions in logic—or are we mere slaves of our nature? You might roll your eyes and scream “It’s a combination of the two, duh!”
To which I refine the question: can we rely on emotional inclinations to make useful investment decisions at all?
In my armchair-psychoanalytic opinion, if I may, there are three emotions that motivate investing moves: anxiety, depression, and euphoria. And your personality determines how either prone or averse you are to any of these.
Anxiety—comes from listening to the media make grandiose predictions about the inverted yield curve and trade war in 2019.
Depression—comes from 50% of your portfolio invested in REITs in 2008.
Euphoria —is your Apple stock you invested in 2006 paying you through the nose in 2020.
All are motivators.
As Registered Investment Advisors, we’ve seen the ultra-conservative who can’t handle the anxiety the media propagates, so they quickly trade; the pessimist that pulls out of the market in 2008, kicking themselves for investing in the first place (and, of course, forswearing the historical gains that followed); and the adrenaline junkie, fueled by both wins and losses, feening for the next miraculous stock performance.
As illustrated, acting on these motivators is, essentially, a gamble. That is to point out that there is a reason people have a gambling problem: the emotional highs and lows are as addicting as narcotics. This is why so many big-wig investors—Buffett, Booth— tell you to kick the habit. Like drugs, you may feel good (or not) in the moment, but it’s never worth it in the long run.
Active investors might contend that they predicate their market-moves on ultra-diligent analysis of historical records (some call it, “recency bias”) and financial projections, not emotion. And that may be true. But they are still human. They do have personalities. They do have emotions (or at least some do).
But it’s a statistical fact that active investors underperform their benchmark index over longer periods of time more often than not. According to a 2019 Morningstar report, referenced by this article, “Only 23% of all active funds topped the average of their passive rivals over the 10-year period end[ing in] June 2019.” Of course, active managers again argue that they fair better in the short term. “Nearly half (48%) of active U.S. stock funds survived and outperformed their average passive peer over the 12 months through June 2019, up from 37% in the year ending June 2018.” But even in those short periods, management fees, commissions and transaction costs eat up chunks of your returns, anyway.
And to that point, my dad wasn’t wrong to be conservative. Because you really don’t know what’s going to happen. He treated his money with his future in mind during every transaction or donation. (And if we expect our politicians to do the same, why not start by setting the example?) In that sense, relying on his gut actually proved him a venerable budgeter.
However, not investing cost him in the long run.
If he had simply invested that 10k in the S&P in 2000 and said sayonara for the next 20 years, he would have $29,743.56 by now. Funny enough, many would consider that a conservative way to invest.
The point is, because you haven’t the slightest idea of what exactly will happen in the next years, you can’t rely on the knots in your stomach to lead you to long term success.
You can, however, rely on the market altogether, by investing in a low-cost globally diverse mix of index funds, staying invested and rebalancing, as needed. Over long periods of time, your portfolio will yield a better return than if you tried to time the market. Because, after looking at their gains, no one should be left asking “what the wow is going on here?!”
Read the original posting here.