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Have you ever wondered why some people seem comfortable investing most (maybe all) of their savings in high-flying stocks while others cling to the safe but low returns offered by short-term Treasury securities?
We’re not talking about professional money managers who spend their days watching the markets, analyzing financial data, and trying to read the latest economic tea leaves. This is about why some of us readily put our money into a mix of stocks and bonds and keep it there for years, even decades, without panicking or losing sleep when things hit a rough patch, while others constantly trade in and out of one investment or another, trying to “time” the market.
An individual’s relationship with money and investing can be complex. While financial advisors talk with clients about “risk tolerance” when crafting an appropriate investment mix, it’s not an easy concept to define. This article looks at widely recognized personality traits and communication styles researchers have identified that affect an individual’s approach to and level of comfort with investing.
What Factors Make Some People Naturally More Comfortable with Investing?
If you had to guess the characteristics that might affect one’s attitude toward investing, you might start with some obvious traits such as gender, education, age, and income. While all of these things may impact your investment “style,” several studies show your personality has a bigger effect than all those other things combined.
Specifically, research shows that the widely used “Big Five Personality Traits” known as OCEAN—openness, conscientiousness, extraversion (or “extroversion”), agreeableness, and neuroticism—significantly influence individual investors’ decision-making and investment behaviors, even after controlling for demographics and other characteristics.
Defining the Big Five Personality Traits
Here is a closer look at the Big Five Personality Traits:
Openness – People who rate high in openness are curious, eager to learn, imaginative, and enjoy new experiences. They also tend to be open-minded and willing to listen to different points of view.
Conscientiousness – People with a strong dose of this trait tend to be responsible, organized, hard-working, and goal-directed. Conscientious people are likely to follow rules and norms and can delay gratification fairly easily.
Extraversion – Individuals who consistently exhibit this trait are sociable, talkative, assertive, and emotionally expressive. Extraversion describes people who tend to gain energy in social situations.
Agreeableness – Agreeable people are generally kind, helpful, considerate, and are often willing to cooperate unselfishly. They may also be optimistic about human nature.
Neuroticism – People with a higher level of this trait have an increased tendency to experience negative feelings such as anxiety, depression, and self-doubt. They may overthink situations and have difficulty relaxing.
How Do the Big Five Personality Traits Relate to Investing?
Before you decide you simply cannot be good at investing because you are not a risk taker or because you are disorganized and break rules now and then, hold on. None of us perfectly matches just one of these personality traits, and while one trait will likely be dominant, most of us exhibit some or all of them to some degree.
In fact, as we explain here, the way these traits affect someone’s approach to investing may not be what you expect.
Openness – This trait is associated with lower risk aversion, so people who are high in Openness tend to be comfortable investing in stocks. Taken to extremes, openness to taking outsized financial risk could be a problem. Openness is also linked to adaptability and willingness to consider new information and strategies. That can support good long-term investing if you are willing to adjust your portfolio as needed without overreacting to the market’s fluctuations. But being too willing to consider new information can be bad if it means grabbing onto every new investment idea.
Conscientiousness – Investors whose dominant trait is conscientiousness will likely stick to a thoughtfully constructed investment plan, avoiding impulsive decisions such as selling in a panic or chasing whatever stocks had the highest recent returns. They are more likely to maintain a disciplined approach to investing, which is crucial for long-term success. Research shows this trait is positively correlated with greater savings and wealth accumulation, likely because those with a high level of conscientiousness are organized, diligent, and prefer to make plans and follow the rules.
There is also a downside to conscientiousness. While this trait can help people succeed as investors, people who exhibit it to a strong degree can also be a bit rigid and stubborn and may resist the changes a financial advisor suggests. Perfectionism can be inefficient when overly conscientious people spend a lot of time on unimportant details.
Extraversion – People with high extraversion tend to like excitement, meaning they are comfortable taking risks when investing and are less likely to sell when the market has dropped. That’s a good thing when it comes to taking the long view.
However, because extroverted individuals thrive on social interaction, they can be susceptible to herding behavior, meaning they may be more likely to follow popular investment trends within their social circles. This can lead them to pursue investments favored by others, which can interfere with independent decision-making. Extraverted investors may also buy more when investments are overpriced, perhaps driven by their optimism, and rely on mental shortcuts, which can lead to decisions they may regret later.
Neuroticism – People with high neuroticism tend to be cautious about investing. Those for whom this is a dominant trait tend to have pessimistic views about future stock returns, so they are not eager to invest their savings in stocks. They generally prefer less risk, react emotionally to market swings, and often feel that market crashes are likely. Their emotional reactions may lead them to sell investments during market downturns, which hurts long-term investment performance. This is the only one of the Big Five Personality Traits with no real upside in investing.
According to researchers, the Agreeableness trait, associated with being cooperative and concerned about others, does not have much to do with how people approach investing or whether they avoid the stock market. If this is your most dominant trait among the Big Five, you might look to the second trait that most closely describes your personality for insights into your attitude and behaviors toward investing.
Understanding Personality Traits Can Help You with Investing
We cannot change our personality the way we might change our diet, so how does knowing which traits are dominant help us with our investments?
First, being aware that one or more of your personality traits likely affect your approach to investing can help. For example, if you have a high level of openness, you may be vulnerable to investment ideas you hear from friends, colleagues, or social media. When you listen to an exciting new investment idea, you could remind yourself to pause, seek other input, and “sleep on it” before committing.
Second, if your spouse’s dominant personality traits differ from yours, simply recognizing that can help you both understand why you look at investing differently. You can then help each other avoid the investing pitfalls of your respective dominant traits.
Third, understanding how your dominant personality trait affects your approach to investing can be tremendously helpful to your financial advisor. Your advisor can provide information and support tailored to your unique traits and needs, which will help you feel more comfortable with that advice.
Your Communication Style Affects How Financial Advice Works for You
In addition to your personality traits, your communication style affects how you talk and feel about money and investing. This, in turn, can significantly impact how well a financial plan you and your advisor create fits your needs. The field of Behavioral Finance, which focuses on the various ways psychological influences can affect investors and market outcomes, has produced valuable research on investors’ communication styles.
At Gold Medal Waters, we use an industry-leading tool developed from this research to help our clients identify their communication styles. This information lets us better interpret the motivators underlying your goals, concerns, and questions. With these insights, we can do an even better job tailoring financial advice so that it “feels right” and truly responds to your unique needs. That means you are more likely to stick with the plan, which will ultimately allow you to achieve the goal of using your money to bring more value to your life.
This article was originally published here and is republished on Wealthtender with permission.
