Everyone loves to learn something about himself/herself. This is exactly what we will do in this blog. We will look into your inner investor. Learn what kind of investor you are and what biases you may hold. I am really enthusiastic about this topic and cannot wait to share this knowledge with you. We will start with reviewing standard classification and definitions and then look into some alternative classification. When you look through them you will notice that they are quite similar and based on ability to take a decision, risk tolerance and handle information.
Please keep in mind that with age and change in financial situation your personality type may shift and will not stay the same over whole life.
What you should take from Part 1 and Part 2 approximate investor type you are and start self analysing some personal biases that my cloud your investment jugment. Also start to think, how you could avoid these errors. Quite a few can be avoided with preparing IPS, which I have reviewed in my previous blog (Link)
What type of investor you are?
There are four generic personality types:
- Cautious Investors
- Methodical Investors
- Spontaneous Investors
- Individualist Investors
Cautious investors are generally averse to potential losses. This aversion may be a consequence of your current financial situation or of various life experiences, but mostly you may exhibit a strong need for financial security. Being a Cautious investor usually results in a desire for low-volatility investments with little potential for loss of principal. Although you generally do not like making your own decisions, you are not easily persuaded by others and often choose not to seek professional advice. You dislike losing even small amounts of money and seldom rush into investments. As a result, you may often miss opportunities because of over analysis or fear of taking action. Your investment portfolios generally exhibit low turnover and low volatility.
You would be in the group that relies on ‘hard facts.’ As methodical investors, you may intently follow market analysts or undertake research on trading strategies. Even when your hard work is rewarded, you typically remain on a quest for new and better information. Your reliance on analysis and database histories generally keeps you from developing emotional attachments to investment positions, and your discipline makes you relatively conservative investors.
You may be Spontaneous investors if you are constantly readjusting your portfolio allocations and holdings. With every new development in the marketplace, you fear a negative consequence. Although as spontaneous investors you generally acknowledge that you are not investment experts, you doubt all investment advice and external management decisions. You are over-manage; your portfolio turnover ratios are the highest of any personality type. Unfortunately, although some investors in this group are successful, most experience below-average returns. Your investment profits are often offset by the commission and trading charges generated by second guessing and frequent adjustment of portfolio positions. As Spontaneous investors, you are quick to make decisions on investment trades and generally are more concerned with missing an investment trend than with their portfolio’s level of risk.
This group has a self-assured approach to investing. As Individualists, you gain information from a variety of sources and are not averse to devoting the time needed to reconcile conflicting data from your trusted sources (Link). You are also not afraid to exhibit investment independence in taking a course of action. You place a great deal of faith in hard work and insight and have confidence that your long-term investment objectives will be achieved.
In the table below you can see how these four types relate to decision making and level of risk.
So based on the description above, you can start looking into the table and place yourself as an investor. You do not have to have traits of just one type. But will most likely have a combination with a tendency toward one Personality type.
You could find the same article in the following website: Link
Alternative Clasification for Personality Types
Here we will into more specific models, that were created and provide with futher reading material if needed.
Bailard, Biehl, and Kaiser Five-Way Model
The classification is very similar to Personality types which we have discussed before,. Through, combining few methods gives better insight into your individual personality. Also, this classification has better names!
You would be concern about the future. The goal is to protect assets and you may look for an advice from someone, who you think knows more about investment.
You feel independent and confident. This could be seen via your life choices or work. You like making your own decision but like to investigate all for and against/information. If you feel that you are a rational investor and process information with an objective view, listen to advice.
The Straight Arrow:
This classification is a theoretical average investor, who does not have one clear personality type. They are sensible not over emotional and objective. You would be this investor, who rationally accept higher return with higher risk. Straight from university curriculum. If you are honest with yourself, it is unlikely you are this investor.
Do you like to be the centre of attention? You have some good idea about some things and understand limitations. You may even look for advice about investing.
You love risk? You like to take chances to the level where it might not be longer called investing, but gambling. You are confident and do not like taking advice from someone else.
The Pompian behavioural model
The model is based on behavioural investor types (later BITs). You go through four steps to decide your personal BITs. I will provide a further reading at the end of the blog.
- Decide if you are active (trade specific stocks, have no mostly no indexes) or passive (invest in index ETF) and leave it there. This way deciding, what is a level of risk willing to accept.
- Think about yourself and decide what is your risk tolerance.
- Think about your behaviour biases (we will go in few in this section, but will have separate blog post, dedicated just for that)
- Finally, decide what is BITs
With no further delay, let’s dig in and found out, who you are.
Behavioural Investor Types (BITs)
The Passive Preserver:
- Low-risk tolerance
- Decision making affected by emotional bias
- Do not like to risk your own capital.
- Low investment experience
The Friendly Follower:
- Low to Moderate Risk tolerance
- Decision Making usually affected by cognitive (faulty reasoning) errors
- You tend to overestimate risk tolerance and go for the most populate investment without regards to overall portfolio and future goals.
The Independent Individualist:
- Active investor.
- Willing to risk capital to gain wealth.
- Risk tolerance Moderate to High.
- Also cognitive errors.
- You like to invest, have a strong will and tend to go for contrarian strategy.
- Would listen to sound advice.
The Active Accumulator:
- High-risk tolerance.
- The aggressive investor, who may even have some experience as an entrepreneur.
- Likes to get to details and really involved with investment.
- Strong will and confident.
Some Issues with Behaviour Types and Conclusion:
- You may have both cognitive and emotional biases.
- You may not be able to place yourself in just one bracket. We are all different
- You need to review your personality and preferences over your life as these will change.
- Even if you managed to find your type you should pay attention to your personal circumstances.
- The aim is to act rationally, but sometimes it is very hard. Hopefully, when you know more about yourself it is easier.
Behaviour Finance is relatively new subject in investing. However, very important when it comes to actual investment and not just theory. We are just people and do not act rationally. So by limiting human factor in our investment decisions, we are more likely to be successful. This science is not as accurate as Maths, but we are not that simple and reading about this subject allows us to make much less error when we start or when we think what to do in the downturn.
Few books for further reading if you are interested in this topic. The first one is written by Michael Pompian.
- Behavioral Finance and Investor Types: Managing Behavior to Make Better Investment Decisions (Wiley Finance) 1st Link
- The Intelligent Investor, Rev. Ed Link The Legend of investment Benjamin Graham was a fan of looking into investment from the more practical side. There multiple referrals to investors behaviour in his book and he gave many practical examples. I will recommend this book time to time when relates to the subject. It is really a must read for every intelligent investor.