The Psychology of Investment
by George Hatjoullis
It is somewhat incongruous that someone with my background has read so little of the burgeoning academic literature on behavioural finance. My study of economics, finance, and psychology, all at postgraduate level, has barely cross-fertilised. Perhaps it is because my professional career involved ‘living’ behavioural finance and a deep suspicion that those that research it have no clue as to the complexity of the issues. I also do not read psychology self-help or how to trade books. It occurs to me that my own experience of investing, trading, and market analysis may have some relevance to others.
Somewhere on a column in Delphi once sat the maxim γνῶθι σεαυτόν; know thyself. This is possibly the most important thing to remember in investment. It does not matter what Warren Buffet did, says, or thinks, you are not Warren Buffet. What can you achieve? The users of psychometrics in many spheres of life (recruitment especially) imply faith in the idea of stable and identifiable personality traits. It does not require that personality is immutable. It requires that the measured traits are stable and accurate for the practical future. It does seem that these tests can say a great deal about who you are at some point in time and certain traits seem to linger. If one accepts that there is a ‘you’ as a well-defined set of traits then there is a ‘you’ as an investment personality. This should be everyone’s starting point in investment. Who are you?
The robo-investment-advisors that are now springing up everywhere put you on a ten point scale of risk, low to high. You are meant to choose one. Great if you have any idea about your risk tolerance and if a ten point linear scale captures it! The reality is that no one knows who you are (including you and psychometricians) until the proverbial hits the fan. Investment is thus a process of self-discovery as much as a rational exercise in strategy. The trick is to stay solvent during the discovery phase and to accept what you find. It may be that your personality limits what you can achieve. This is true of life in general. Despite the exhortations, you cannot be anything you want. There are always limits. The limits may be your own personality but this does not mean it is a simple matter to change and expand. In investment it is best not to breach these limits. It can be financially fatal.
I have recently got to pondering which dimensions of personality would make sense when defining an investment personality (in retirement one does a lot of pondering and occasionally blogs about it). Interested-Disinterested seems the place to start. It is not an obvious dimension. Why should an interest in finance be a personality trait? Logically it should not and it is almost certainly a manifestation of a more fundamental dimension. Nevertheless it is evident that people have a consistent (lack of) interest in finance issues. It is a chore, like doing the dishes, and something to be got out-of-the-way. Cynical-Trusting is a more obvious dimension.
If you are interested and cynical, DIY investing seems the inevitable route. If you are interested and trusting, discretionary management with careful research into advisor choice is the likely approach. If you are disinterested and trusting, discretionary management is the probable choice but with less research into advisor selection. But what if you are disinterested and cynical? Here lies real danger. Even these simple dimensions give some helpful guidelines. If you are not interested in finance then it may be wise not take too much risk. The danger is you will do a poor DIY job, or a poor job in advisor selection and engagement. If you are interested then you can afford to take more risk. Note that this is independent of time horizon or how much money you have or what you are trying to achieve, which is what most ‘experts’ will focus on.
If your eyes glaze over whenever a conversation involving investment begins and you regard all investment advisors and discretionary managers as charlatans, then you really ought not be taking very much risk. You might get lucky (in which case buy premium bonds) but most likely things will go wrong. If you perk up when the news gets to the financial section and you feel there are good expert advisors and discretionary managers, then you can afford to take more risk. Chances are you will identify a manager with whom you feel comfortable, engage, and monitor progress judiciously. Your personal interest and degree of trust will influence outcomes as much as anything else.