My colleague Paul Nixon who is head of behavioural finance at Momentum Investments, has dug deeply into how our behaviour influences our investments.
Paul has coined the term “behaviour tax”, which refers to how our investment behaviour – triggered by our innate response to market movements – can have negative financial implications. This phenomenon is very real and we see it frequently.
For example, during Covid-19, we saw a wave of investors “jump ship” on unit trusts in fear, because of the market uncertainty caused by the pandemic. But this knee-jerk response ended up costing investors around R650 million in value – as they could not time the market and thus lost out on the upside – a very steep behaviour tax.
We use this example to illustrate to clients the importance of staying invested when there are global shocks, as the market generally recovers, along with your investments.
Paul has recently taken an interest in personality types and in his recent article, “How your biology affects your financial behaviour”, Paul writes: “The links between biology, chemical processes and financial behaviour are now more widely studied … the personality dimensions that form the basis of modern personality theory are rooted deeply in our genetic code.”
Coming from a psychology background and working in the Wealth Management space, I am fascinated by the interplay between personality and financial behaviour.
When considering the two main personality groups – introverts and extroverts – we typically see that introverts are more likely to seek security in their investment outcomes and are therefore more cautious when taking on volatility risk.
They will investigate the “what if” scenarios and if they cannot find a sense of safety, it will cause them a lot of anxiety. When they see poor investment returns due to a market downturn, they are the first to contact their financial advisers to inquire about lower-risk investments.
The problem with this response is that it doesn’t factor in the long-term loss of returns caused by switching, which might cause them even more anxiety when their investment goals are not met over time.
Extroverts, on the other hand, are more open to challenges and risk, and have a sense of spontaneity that makes them more amendable to volatility in exchange for potentially higher return solutions. For instance, we’ve seen many instances where those investors identifying as extroverts have requested investment alternatives to equities as an asset class – these classes are considered higher risk, but with the potential for higher returns.
As a business, we have also extensively studied the link between emotions and investment decisions. In a financial context, emotions can cause problems, which is down to the fact that they’re not always an accurate depiction of reality, but rather a reflection of each person’s personal experience and perspective, which guides their response.
While emotions are an important part of life, in an investment environment, they can be bad news. We advise our clients to not let emotions be the only part of the reasoning when making investment decisions. We’ve seen clients be unnecessarily cautious due to fear of loss, investing in low-risk assets or solutions that not only limit their returns potential but could also hamper the achievement of their goals due to the risk of inflation.
On the other hand, the tendency to take ridiculously high risks driven by a hopeful and overconfident emotion could result in the misalignment of risk.
But emotions can also contribute to better investment outcomes. Confident, bold personalities are generally more willing to take advantage of new investment opportunities, which can often work in their favour. Those who are cautious tend to think more carefully about investment decisions, and often have a deeper understanding of investment philosophy, knowing that periods of volatility are part-and-parcel with long-term investment.
A documented financial plan, created together with a financial adviser, will be valuable to these clients, as it will help them manage their fear and remain invested in periods of uncertainty.
No personality type will always get it right as market conditions change. The key is for investors’ emotions to be congruent with the facts, and to do this, they need to move from emotion to evidence.
This is where a savvy financial adviser can play a starring role in helping investors separate fact from fiction while helping them build a solid financial plan that will help them avoid the fear and greed that we see in periods of market volatility.
In future, it will become even more important for financial advisers to have a deeper understanding of their clients’ personalities, as this will inform their emotions and behaviour, and the kinds of decisions they’re likely to make.
— Sonja Steyn is the head of wealth management strategy, private wealth and business management at Consult by Momentum