Investing, like much in life, is a skill. Mastering it, however, is not as simple as sticking to theory. Choices in investing are often not black and white. Emotions can come into play and your personality type may influence how you invest your money.
The two “investment personality” extremes are quite straightforward: on one hand, there is the risk-taker; on the other, an individual who is ultra-cautious.
We all know someone who’s a risk-taker – the kind of person who is comfortable making choices that can have extreme positive or negative consequences. We also all know someone who’s ultra-cautious – the kind of person who spends weeks buried in spreadsheets before they make the most straightforward decision.
However, not everyone falls neatly into one of these two categories. The majority of investors fall somewhere between the two extremes.
Discovery broker Louw Venter says that in the course of his work he meets many different financial personalities: “I see clients who lost money early and are now afraid, I see dreamy-eyed investors who are idealistic about how much money they can make, I see greed and I see fear. But you have to understand that everyone is different, and you have to work with the various personalities.”
Becoming better informed
It’s neither good nor a bad to be a risk-taker, cautious investor or somewhere in between. What’s far more important isunderstandingyour investment personality. Identifying what kind of investor you are can help you make better-informed investment decisions.
The benefit of understanding your investment personality is that you can compensate for areas where you are weaker. For example, if you know you are a risk-taker, you should be able to actively adjust for your first instincts and possibly make more conservative investment decisions.
Venter says one of the important tasks of any financial adviser is to understand clients’ investment style: “The knowledge base of the investor is critical in determining a suitable investment strategy. The adviser needs to find this out by asking the right questions.”
Financial advisers understand the typical correlations between personality type, portfolio choices made and investment results. There is no one-size-fits-all answer. There never is. Your personality type is just one of the many variables (including life stage, debt, career, current portfolio) that you and any financial adviser have to consider when planning your financial future.
Risk friendly or risk averse?
The American bank BBVA Compass suggests there are a four basic questions that will help you understand what kind of investing personality you have:
- Can you tolerate a high risk of losing money?
- Do you expect to make extremely high returns?
- Are you comfortable with investing over a long period of time (more than 10 years)?
- Will you need access to some or all of your money at short notice?
If you answered “yes” to all the questions, you are probably an aggressive investor: “You believe that over time, the stock market will go up. You are willing to take the risks of ups and downs in the stock market, because you believe that’s where the most money can be made.” Aggressive investors, who are comfortable with risk, tend to favour equities. Within equities, less cautious investors tend to make snap decisions. They may, for example, think nothing about sticking 5% of their portfolio in a new listing or in a small or mid cap that they’ve heard good things about.
Venter says that risk-loving clients can be more difficult to work with. “Risk-takers worry me the most – often they feel good when they make money, but when they lose money it becomes more difficult. These personalities like jumping into the deep end.”
However, he points out that there is a big difference between risk-takers who “have made volatility their friend and are prepared for the consequences” and greedy investors who try to make a quick buck, but do not have the necessary knowledge.
On the other end of the continuum are those who answered “no” to all the questions. These are ultra-conservative investors who typically steer towards cash and bonds, and are more concerned about the potential loss of capital than they are about potential returns. They simply don’t tolerate risk.
You’ll typically find that risk-averse individuals calculate and extrapolate virtually every possible eventuality before making an investment. They’re the kind of person who reads all the fine print, including (often complicated) costs and performance fee schedules. Their equity exposure is typically be via balanced funds.
From a financial adviser’s perspective, these clients can be more easily managed. “My role as a financial adviser is to make them comfortable with volatility over time – but you can do it slowly, until they feel comfortable with more risk,” says Venter.
Between the two extremes are those who answered “yes” to some questions and “no” to others, and these people are likely to balance their investments between the various asset classes, including equities and cash.
Finding a balance
Canadian investment resource Investing for Me suggests that the first of those four simple questions (Can you tolerate a high risk of losing money?) is key in understanding what kind of you investor you are: “For the most part, an analysis of your investing personality is focused upon how you respond to losing money. Do you accept the loss and move forward? Or does the lost money bother you for days and months later?”
A knowledgeable financial adviser interprets your responses to these kinds of questions. Understanding your responses will assist you in finding an investment strategy that strikes a balance between offering you comfortandattempting to remove unhelpful emotions from your investment and saving decisions. This will allow you to compensate for your biases by increasing the equity portion of your portfolio if you’re too cautious, or making certain that you have exposure to other asset classes if you are too much of a risk-taker. Your portfolio will be the better for it.
For more information on investing, speak to your financial adviser.
This article is part of an investment series by Discovery Invest.
Discovery Invest is an authorised financial services provider. Registration number 2007/005969/07. For more information on Discovery Invest, contact your financial adviser.