Researchers have looked at characteristics like age, wealth, intelligence, and financial literacy and found that these factors don’t fully explain the wide variety of investment choices and outcomes. Concepts like risk aversion and time preference play an important role in shaping investor behavior, “but underlying all of those variables is still the question: What psychological or mental processes drive this difference?” says Kellogg associate professor of finance Zhengyang Jiang.
A recent paper Jiang wrote with Cameron Peng of London School of Economics and Political Science and Hongjun Yan of DePaul University examines the relationship between personality and investment decisions. Tapping a model widely used by psychology researchers, the coauthors show how the Big Five personality traits correlate with investors’ beliefs about the stock market and the economy, their risk preferences, and their tendency to be influenced by the investment decisions of their peers.
Two traits in particular—neuroticism and openness—correspond with investors’ aversion to or preference for buying equities. “People with high neuroticism tend to be the ones who invest less in the stock market, even after we control for the other types of individual differences,” says Jiang. “People with lower neuroticism tend to take more risks and buy more stocks rather than safer bond assets. And high openness is correlated with more stock investing and lower risk aversion.”
To carry out the study, Jiang and his coauthors partnered with the American Association of Individual Investors (AAII), a nonprofit organization that teaches individual investors how to successfully build investment wealth. The authors designed a nationwide survey that the AAII distributed via email in 2019 to its membership: about 150,000 individuals who have invested substantial amounts in financial markets.
The study’s key innovation was to combine questions about the process of investment decision-making with a 20-item questionnaire that aimed to determine each respondent’s personality traits using the Big Five model. The personality questionnaire sought to measure:
Next, to shed light on investors’ beliefs and preferences, the survey asked respondents about their expectations related to stock-market returns, economic growth, and inflation in the coming year. It also sought to ascertain their attitudes toward risk and how they reacted when a new financial product became popular with people around them.
Another set of questions focused on equity allocation—specifically, how much money each respondent had invested and what percentage was in stocks. The survey concluded with demographic questions about respondents’ age, gender, race, income, wealth, location, and education level.
Reflecting the AAII’s membership, the 3,325 investors who responded to the survey (a 2 percent response rate) were predominantly white males older than 60. These individuals were more educated and affluent than the general population, with a median reported wealth of $3.5 million. They also were more actively invested in the stock market than most Americans.
Analyzing the survey data, Jiang and his coauthors found that individuals with high openness and low neuroticism tended to invest more in equities—including individual stocks and stock funds. Agreeableness and conscientiousness, on the other hand, played a less significant role in financial decision-making. Overall, the authors reported a strong correlation between people’s personalities, investment choices, beliefs, and risk preferences. “These things seemed to line up pretty well, which was a good sign that we were on to something,” Jiang says.
The power of personality
When it comes to expectations about stock-market returns and the economy, Jiang and his coauthors argue, “personality traits may help explain why some people are persistently optimistic while others are persistently pessimistic.”
Many of the connections are intuitive. The data showed, for example, that highly neurotic investors are much more concerned with downside risk. Investors with high conscientiousness and extroversion, by contrast, expect a lower probability of a market crash. And people scoring high on openness are more willing to entertain the possibility of either an upside or downside.
Personality traits also shape how investors react to the behavior of people in their social circles. The study revealed that both neurotics and extroverts are more likely to adopt a certain investment when it becomes popular among the people around them, but their path to this decision is likely different.
“An extravert derives utility (and pleasure) from interacting with others and tends to copy their investment decisions after such social interactions,” the authors write. Neurotics may also copy their friends, but “one possible explanation is that more neurotic investors have more fear of missing out (FOMO), and therefore tend to follow the crowd.”
Interestingly, Jiang and his coauthors evaluated evidence from Germany and Australia and found it validated the results of their study of U.S. investors. Looking at two additional datasets—the German Socio-Economic Panel Survey and the Household, Income and Labour Dynamics in Australia Survey—they again saw that neuroticism and openness affected market perceptions and decisions about equity investments.
“This finding is surprisingly consistent across cultures, regardless of the language and other differences,” says Jiang. To further test their model, he and his coauthors plan to gather data from China to see if it shows the same links between personality traits and investment decisions.
Using personality to guide investment decisions
Meanwhile, Jiang believes that the Big Five–based approach may be useful for investment advisers who want to better understand the forces driving their clients’ feelings about risk and their preferences about asset allocation. In addition to the standard set of financial questions that advisers routinely ask to gauge risk tolerance, additional questions focused on personality traits could be “complementary and useful, because they shed light on the same issues,” Jiang says.
Armed with new insights about a client’s personality, a savvy adviser could guide them towards more rational choices. “Neurotic people do not like stock-market investment,” Jiang says. “But if you can nudge them to be a little more comfortable investing in something risky, that might be good for them and their family—because they’re probably going to miss the stock-market gains over a long time span if they’re too concerned about the downside only.”
“If you can teach them about themselves, help them to understand themselves a bit better, that could be beneficial for their financial education,” he says. “It could also have a social benefit.”