The role of financial personality in individual decision-making

Greg Davies

Traditionally, the focus of the financial sector has been on building a diversified portfolio of investments that balances growth and risk. Financial advisers have often been tasked with trying to find out an individual’s attitude to risk, along a spectrum that ranges from extremely cautious to those who are prepared to accept a high level of risk in return for potentially greater capital growth. This approach, says Greg, is entirely based on the construction of the portfolio, and it suggests that risk tolerance is the only part of an investor’s personality that matters.

However, Greg believes it is vital to understand the multiple dimensions of financial personality, not just risk tolerance. He explains:

“At Oxford Risk, we measure emotional comfort. That’s because it is vital that an investor is completely satisfied with any portfolio they are invested in, and that consequently they will hold it through all the financial-market volatility that any investor inevitably faces over the long term.”

Understanding an individual’s financial personality, says Greg, requires the consideration of various factors. We’ll look at each of them in turn.

1.    Financial capacity to take risk

This is dependent on issues such as how close someone is to retirement, their overall wealth, and their liabilities, such as the size of any mortgage. If you’re about to retire, for example, you’re unlikely to have the same capacity to take risk as someone who is in their 20s or 30s.

Establishing this capacity is vital to understanding how they will respond emotionally over a portfolio’s lifetime. Greg explains:

“Most people who sell at the bottom of the market downturn don’t need the cash. They simply run out of emotional liquidity, rather than financial liquidity. They effectively become too scared to hold on to the portfolio. That might seem irrational, but if your emotions are telling you to sell, it makes perfect sense to the individual involved, who may be plagued by worries about whether they might be forced to sell their house, etc. We all want to feel emotionally comfortable and to be able to sleep easy at night.”

2.    Composure

Another factor to consider is how anxious an investor is likely to feel over a portfolio’s lifetime. Greg argues that some people naturally have much higher levels of composure; they're more able to keep their eye on the long term, and less likely to be spooked by a newspaper headline and sell up.

A high level of composure can, however, be costly, as Greg points out:

“If someone is too laid back and too focused on the long term, they might not behave sensibly in terms of periodically checking, for example, whether their portfolio still matches their long-term goals, which can change.”

3.    Confidence

Some people are innately more comfortable than others at making financial decisions, and that also influences how an individual approaches the subject of investing. Someone with very little confidence almost certainly needs the help of a financial adviser. Otherwise, they may simply sit on the sidelines – and leaving your money in cash can prove very costly over the long term. By contrast, says Greg, “an overconfident individual might be taking too much risk in the misguided belief that they can outwit the market. So, they might equally do well to consult a financial adviser.”

4.    Impulsiveness

Some people are quite simply more impulsive than others. They may make financial decisions without necessarily considering all the implications. That trait can clearly be risky, especially given that that all of these personality characteristics are interconnected. Greg explains:

“You can get dangerous combinations, such as someone who is low in confidence (financially at least) but is also very impulsive!”

Focus on the individual

Greg concludes by pointing out that it is crucial to measure an investor’s financial personality before recommending any particular portfolio. And the emphasis is on the individual. Generalisations are often made about particular demographic groups – for example, that women tend to be much more cautious investors than men. In reality, though, the differences between men and women, the young and the old, and people from different cultures, to give some examples, are quite small. But within those groups there could be significant variations among individual financial personalities.

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