Knowing your investing personality -Part II
Behavioural finance studies show that our embedded personality traits along with emotional and mental behavioural biases contribute to the “how and why” of our important financial decisions. In a research report released by CFA Institute, investors are categorized on four different types based on their behavioural biases. Here we discuss on the four types and the common issues they face with investing.
Preservers focus on preserving wealth rather than taking risks to grow wealth. They are anxious about losses and short-term performance. Preservers also have trouble taking action for fear of making the wrong investments decisions.
An ideal investment strategy should be segregated into short, medium and long term goals. By focusing on short term returns, preservers risk making an emotional decision based on the short-term performance, which may end up being more detrimental to them in the long run. So, if someone identifies themselves as a preserver, they should clearly define the three different stages of goals and create a plan around it.
Accumulators are confident investors who want to be actively involved in making investment decisions. They are risk takers and typically believe that whatever path they choose is the correct one.
The issue with accumulators is overconfidence. History has shown that it is impossible to predict markets at large scale, yet accumulators continue to try and do so and expose themselves to extreme risk. An accumulator should be honest with their risk taking ability. In other words, put a cap on how much they can afford to lose or how much return they are happy with and be disciplined about it.
Followers may lack interest and/or knowledge of the financial markets. Hence their decision-making process may lack a long-term plan. Followers are investors who tend to follow their friends and colleagues’ advice or follow the current trend.
The downside with followers is that they follow the herd mentality – a concept of investors piling into the same investments as others. This is often the basis of investment bubbles and subsequent crashes in the stock market. A follower personality should invest in themselves and understand their investment decisions and how they fit into their overall plan. Educate oneself on common financial terms and concepts, and understand the “why” behind investing in an asset rather than simply relying on others’ advice.
Independents are engaged investors who have their own ideas about investing. They are often analytical and critical thinkers and trust themselves to make confident and informed decisions, but risk the pitfalls of only following their own research.
Similar to overconfidence bias associated with accumulators, independents face similar issues with relying too heavily on themselves. It is always a good idea to have a second opinion by looking at the market consensus and then settling on an investment.
In conclusion, it is important to understand your investing personality, develop a three-fold strategy, empower yourself with knowledge and then execute your decisions. After all it is your hard earned money that you want to grow and investing in yourself to gain knowledge will help you in the long run and reduce dependency on others.
So, what kind of investor are you?