If you invest regularly you've probably made investment mistakes. Maybe you sold a winning stock too early or held on to a losing stock too long. Mistakes are common in investing, and here at Morningstar we've worked hard to help you avoid them. However, there are mistakes that seem to haunt all of us, the ones where we went against our adviser or followed our gut instinct to no avail.
Robert Durand, professor of finance at Curtin University in Australia, attributes such decisions to personality traits.
Durand and two colleagues concluded in a Journal of Behavioral Finance article that personality traits are associated with a wide range of investment decisions and outcomes. The research for that article and Durand's ongoing research is based on the five-factor model of personality traits, which is the leading paradigm in personality research.
It's an efficient model because it dismisses hundreds of personality traits in favour of the "Big Five," which are listed below along with some advantages and disadvantages they bring for investors:
Extraversion
Extraverts are social, enthusiastic, talkative and assertive. In general, they tend to take on more risk in order to fulfill their need for excitement.
Advantage: They tend to have a higher risk tolerance, which can mean potentially higher returns.
Disadvantage: They may take on too much risk and lose money.
Agreeableness
Those high in agreeableness are trusting, altruistic and optimistic. They need to get along with other individuals.
Advantage: They are cooperative when working with advisors on their portfolios.
Disadvantage: They do not like to offend others and may be hesitant to raise any red flags that they see.
Conscientiousness
Conscientious persons are thorough, careful and diligent. They have the ability to delay immediate gratification in favour of long-term goals.
Advantage: Long-term investors can be patient and restrain themselves from impulsive risk-taking.
Disadvantage: They are too risk-averse.
Neuroticism
Neurotic individuals are emotionally unstable. They are prone to psychological distress including depression, anxiety and anger.
Advantage: They are drawn to risk because of its emotional appeal and, similar to the extravert advantage, higher risk tolerance can potentially equal higher returns.
Disadvantage: They are impulsive; therefore, they are prone to making emotional financial decisions.
Openness to Experience
Individuals who are open to experience are imaginative, curious and receptive to new ideas. They actively seek new experiences. This trait is highly correlated to intelligence. There is no advantage or disadvantage listed because openness to experience/intellect is the least studied of all the traits.
Durand says personality traits are remarkably stable once you reach age 30. Therefore, if you determine your personality traits early on in your investing career and understand how they'll affect your decision-making, then you should be able to avoid some mistakes.
Two of the five factors, neuroticism and extraversion, seem to play a larger role compared to the other traits. Durand says investors scoring highly in neuroticism are attracted to risk, but they seem to find it disturbing. They want to do something about it, but seem incapable of doing so; they will sell risky stocks only to buy others.
Higher extraversion scores are associated with higher returns, even after adjusting for risk. Durand says, "Extraverts are attracted to higher risk, but they manage it better, getting higher returns for higher risk, which should be the case according to standard finance theory."
For a complete personality diagnosis, Durand suggests seeing a professional who can properly administer the test. However, to obtain a rough idea of your personality, you can complete this online test. Durand is not associated with this website. It is administered by Dr Tom Buchanan, of the department of psychology at the University of Westminster in the UK, who is collecting data for online research.
