Personality traits matter for a variety of life outcomes, including health and aging, marital and career success, and economic decisions such as spending behaviors. The same persistent differences in personality traits are found to be related to persistent differences in both beliefs and investment decisions. Thus, financial advisors can add value by identifying these traits and educating investors about their behaviors when designing financial plans.
Zhengyang Jiang, Cameron Peng, and Hongjun Yan contribute to the behavioral finance literature with their study “Personality Differences and Investment Decision-Making,” published in the March 2024 issue of the Journal of Financial Economics. In order to examine the relationship between personalities and investment decisions they surveyed 3,325 members of The American Association of Individual Investors (AAII) with a median reported wealth of $3.5 million. The survey used a 20-item questionnaire (SAPA Personality Inventory) which measures each personality trait to elicit each respondent’s personality traits in the “Big Five” dimensions: Extraversion, Agreeableness, Openness, Conscientiousness, and Neuroticism. These traits are a widely accepted framework for understanding individual differences in personality.
1. Openness to Experience: This trait reflects a person's general interest in new experiences, ideas, and concepts. Individuals high in openness are curious, imaginative, and open-minded. They tend to enjoy learning new things and exploring different cultures.
2. Conscientiousness: This trait reflects a person's tendency to be organized, disciplined, and goal-oriented. Individuals high in conscientiousness are reliable, dependable, and efficient. They tend to be good at planning and sticking to schedules.
3. Extraversion: This trait reflects a person's level of social energy and outwardness. Individuals high in extraversion are outgoing, sociable, and talkative. They tend to get their energy from interacting with others and enjoy being the center of attention.
4. Agreeableness: This trait reflects a person's tendency to be cooperative, empathetic, and altruistic. Individuals high in agreeableness are kind, helpful, and trusting. They tend to put the needs of others before their own and value social harmony.
5. Neuroticism: This trait reflects a person's tendency to experience negative emotions, such as anxiety, fear, and sadness. Individuals high in neuroticism are often described as being moody, tense, and easily stressed.
Personality traits have been found to display remarkable stability within individuals over time. The authors of the empirical research noted: “Research in neuroscience shows that personality traits have a biological basis. In particular, they are related to different brain systems, which are brain areas and neural circuitries that generate given behavioral functions. For example, Extraversion is related to brain systems governing positive emotionality, while Neuroticism is related to brain systems governing negative emotionality. Conscientiousness and Agreeableness are related to neurocognitive systems governing effort control. These brain systems co-evolve with personality dispositions from early stages of development.” Their hypothesis was that the same persistent differences in personality traits would be related to persistent differences in both beliefs and investment decisions. Following is a summary of their key findings:
• The Big Five personality traits correlate with investors' beliefs about the stock market and economy, risk preferences, and social interaction tendencies.
• Investors high in Neuroticism are more pessimistic about average future stock returns and assign a greater probability to a crash. Thus, they invest less. They are also more pessimistic about future economic growth and expect higher inflation. In contrast, investors high in Conscientiousness and Extraversion are more optimistic in their forecasts.
• People with higher Openness are more willing to entertain the possibility of extreme events—they assign greater probabilities to both tails at the same time.
• Personality traits are related to risk preferences. Investors high (low) in Openness are more (less) willing to take risks—resulting in higher (lower) equity allocations.
• Investors react differently to the behavior of the people in their social circles. Those who score high on Neuroticism and Extraversion are more likely to adopt a certain investment when it becomes popular among people around them—they are more subject to herding behavior.
• There was no evidence that Agreeableness plays a direct role in financial decisions.
• Higher Neuroticism is associated with less extrapolative and more mean-reverting beliefs while higher Openness is associated with more extrapolative and less mean-reverting beliefs.
• An investor’s elicited expected stock return and risk aversion are uncorrelated, suggesting that these two measures reflect different aspects of individual characteristics.
• While female respondents tended to have higher Agreeableness and higher Neuroticism, and older respondents tended to have higher Agreeableness, lower Conscientiousness, lower Neuroticism, higher Extraversion and lower Openness, overall, the explanatory power of the demographic variables was small: the R-squareds were 3% to 5%. The demographic variables were used in regressions as controls.
• The results were robust to survey data covering both Australia (Household, Income and Labour Dynamics in Australia Survey) and German (Socio-Economic Panel Survey) investors—providing out-of-sample support for their findings.
Their findings led Jiang, Peng, and Yan to conclude: “Personality traits are related to the cross-sectional difference in beliefs after controlling for demographic variables. 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.”
Takeaways
Jiang, Peng, and Yan showed the importance of incorporating personality traits when developing financial plans and investment policy statements, as well into the financial decision-making process. They also showed the need to consider social interactions as well. Financial advisors can assist their clients by incorporating personality traits and social interactions into the discovery process they use to determine investor goals and risk tolerances. They could also utilize the SAPA test to better understand the personality type of the client, and how their social interactions might impact their financial decision-making and risk-taking behaviors.
Keeping in mind that most battles are won in the planning stage, obtaining this knowledge can provide advisors with the insights needed to anticipate behavioral problems that might arise and educate investors about them ahead of time. In that way investors will be more likely to adhere to their well-thought-out plan—education provides the armor to protect ourselves against our own behaviors. Forewarned is forearmed. Those interested in learning about their own personality traits you can take a free confidential SAPA test here.
Larry E. Swedroe is head of financial and economic research for Buckingham Wealth Partners.