When it comes to investment decisions, 2 personality traits stand out, study says

Researchers examining investor behavior found that even with differences in age, wealth, intelligence and financial literacy, investment decisions actually come down to two personality traits: neuroticism and openness.

The investor personality study was a response to the apparent homogeneity of investment styles despite demographic differences, according to a paper by researchers from Northwestern University, DePaul University and the London School of Economics published this month by the National Bureau of Economic Research.

“Overall, the empirical evidence suggests a need to expand the set of characteristics to explain the process through which people make investment decisions,” according to the report, “Personality Differences and Investment Decision-Making” by Zhengyang Jiang, Cameron Peng and Hongjun Yan.

The study focused on 3,325 wealthy individuals with a median of $3.5 million and found that investment styles align with two of the five “Big Five” personality traits of extraversion, agreeableness, openness, conscientiousness and neuroticism, as determined by a 20-item questionnaire.

'Neuroticism stands out'

“Neuroticism stands out: investors high in neuroticism are more pessimistic about average future stock returns and assign a greater probability to a crash,” according to the report. “They are also more pessimistic about future economic growth and expect higher inflation.”

Openness was the other key trait, with a direct relationship with risk tolerance – the more openness, the more risk tolerance. Along with those high in neuroticism, people low on openness tended to invest less in equities.

The investor personality traits operate on different tracks though.

“These two traits appear to affect investment decision-making through different channels: high neuroticism is associated with pessimistic beliefs about future stock returns and tail risks, whereas low openness is associated with high risk aversion,” according to the report. “Moreover, the two traits remain significant in explaining asset allocations even after controlling for risk aversion and return expectations.”

The researchers analyzed data from two other studies, one in Australia and the other in Germany. Both showed that the traits of neuroticism and openness correlated with equity holdings, even in other populations and business cycles.

Neuroticism is defined as chronic emotional instability and a tendency for psychological distress. “More neurotic people are less predictable and less consistent in their emotional reactions,” according to the report. “They tend to be flippant in the way they express emotion and are more likely to interpret ordinary situations as threatening and minor frustrations as difficult.”

Openness is the tendency to be open to new aesthetic, cultural or intellectual experiences. “People who are open to experience are intellectually curious, open to emotion, sensitive to beauty, and willing to try new things. They tend to be more creative and more aware of their feelings. They are also more likely to entertain unconventional ideas.”

The researchers also pointed out that personality traits tend not to vary over time, contributing to the consistency not only across demographic groups but also across cultures and eras.

“Personality traits are related to the cross-sectional difference in beliefs after controlling for demographic variables,” according to the paper. “This result puts forward personality traits as promising variables for understanding why some people are persistently optimistic while others are persistently pessimistic. In a similar spirit, we also show that personality traits are correlated with cross-sectional differences in risk aversion and social interaction.”

Channeling the traits

The U.S. study showed that personality traits to affect investment decisions through three channels – beliefs, preferences and social interaction tendencies.

Those scoring high on neuroticism and extraversion are more likely to jump onto an investment if people in their social circles were talking about it. The traits also affect the perspective about stock returns. Higher neuroticism is associated with a stronger belief in mean-reversion, that asset prices and returns will eventually settle back into their average level. Openness is associated with extrapolative belief, meaning they expect individual stocks to perform based on extrapolations of recent stock returns.

The researchers found that the traits that affected investing were not the same that affect other areas of economics. So, agreeableness is a key driver in the labor market but does not play a direct role in investing.

Personality traits tend not to vary over time because they are rooted in biological development.
“Extraversion is related to brain systems governing positive emotionality, while neuroticism is related to brain systems governing negative emotionality,” the researchers wrote.

“Conscientiousness and agreeableness are related to neurocognitive systems governing effort control.”

That is a reason that observing the traits can help predict life outcomes, such as marital success, health, spending and job performance.

In the realm of investing, the researchers found the traits of neuroticism and openness are key, with high neuroticism and low openness related to low equity holdings. But they do this through different channels.

High neuroticism equals low expected returns and high crash anxiety, but actually does not correlate with risk aversion.

“Hence, the effect of neuroticism on equity allocation is likely through the belief channel,” according to the report. “In contrast, high openness is associated with low risk aversion, and high perceived risks, but has no significant correlation with expected returns. That is, this effect is dominated by the preference channel: investors with high openness have low risk aversion and hence high equity allocation, despite their high perceived risks.”

The traits can also show why people invest for entertainment and social connection. Some investors like to treat stocks like gambling and share information with friends. ESG investing, for example, can also be a social expression of values.

Steven A. Morelli is a contributing editor for Insurance Newsnet. He has more than 25 years of experience as a reporter and editor for newspapers and magazines. He was also vice president of communications for an insurance agents’ association. Steve can be reached at [email protected].

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