What is Your Investment Personality Type?
By Katherine L. Moss

Emotions play a significant role in investment decisions, sometimes causing people either to fear losing money, to buy into a “hot” stock, or to feel buyer’s remorse. From the seventeenth-century Dutch tulip mania to dot-coms in the twentieth century, investors have been unable to separate themselves from their emotions.

Acting without emotion is extremely difficult when making investment decisions. Therefore, it is helpful to recognize one’s emotions surrounding investing and take them into account.

Behavioral psychologists Daniel Kahnemann and Amos Tversky began studying behavioral finance in 1979. They introduced the “Prospect Theory,” which studies how people manage risk and uncertainty. [i] Their research indicated individuals are more worried about losses than they are happy about equivalent gains.

For example, when investors were given a hypothetical $1,000 to invest, they were more likely to accept a sure investment gain of $500 than a 50% chance of gaining either $1,000 or nothing. However, the opposite was true with possible losses. When given a hypothetical $2,000, most investors chose not to accept a sure loss of $500 on the investment, opting to take a 50% chance of either losing $1,000 or losing nothing.

The ongoing study of behavioral finance has uncovered common investor characteristics, which can help determine your investment personality and help you understand the investment decisions you make.

Herd Mentality. Some investors figure if everyone is buying a particular stock, it’s got to be a good, safe investment. But when they go with the flow, investors do not take the time to adequately research a particular investment. Therefore, they are not making an informed decision. People do not want to regret making a bad decision, but herd mentality allows them the comfort of knowing they aren’t alone in their decision.

Overconfidence. Investors tend to be overconfident or self-assured in their abilities. According to John Nofsinger, author of The Psychology of Investing, overconfidence stems from two things:

Overconfidence can influence investors to trade too frequently and hold onto riskier investments too long. In fact, University of California at Berkeley finance professor Terrance Odean studied 10,000 brokerage accounts during a six-year period, and concluded that in a portfolio of winners and losers, individual investors were twice as likely to sell the winners as opposed to the losers. [ii]

First Impressions. People equate investing with their first investing experience. If they choose a winning investment the first time they invest, they perceive investing as less risky. Investors tend to use past investment outcomes to evaluate a current situation. Perhaps this is the reason for the disclaimer: “Past performance is not indicative of future results. Your investments may earn more or less.”

Risk Aversion. Investors will most often choose a sure thing over another choice that has a potentially higher return, but involves more risk. People are generally risk-averse; they seek actions that inspire pride and avoid actions that create regret. Pride is the pleasure investors experience when investments perform well. Regret is the pain investors feel when investments perform poorly, causing them to second-guess their decisions. The feelings of pride and regret will cause investors to sell good investments too soon and hold onto bad investments too long. When this happens, investors will pay more capital gains taxes and earn a lower return.

Out of Context.People react to information based on how it is received, and will only see the “frame of reference” rather than the big picture. So, if an investor looks at a mutual fund’s performance over a one-year period rather than over the life of the fund, the information could be taken out of context. That one-year period could represent the one down (below market) year the particular fund experienced, when historical information shows the fund outperformed the market in other years.

Investors want to make the right decision about their investments. Unfortunately, emotions have a tendency to affect behavior. Finding clarity around your emotions and how they affect your investment decisions is critical. The end result of any planning process depends entirely on the level of clarity attained at the beginning. In order to make the best investment decisions, investors should work with a financial professional to become aware of their investing behaviors and try to manage them.

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