Your financial personality influences your attitudes to money and investing, so understanding a bit more about it can help curb bad habits and build good ones.
Just as there are optimists and pessimists, thinkers and doers, each of us has a financial personality that shapes our attitude towards money: spending, saving, and investing. The key is not to try and change your financial personality, but to be aware of
it and work with it to get the best outcome for your long-term prosperity.
The influence of childhood
Perhaps you were taught to save up for treats, given a bank account from an early age, with pocket money dependent on chores. It could be that money was a source of conflict. You will also be influenced by whether your family was wealthy or if money seemed
scarce.
Your financial personality will affect the way that you spend: the ‘spendthrift/tightwad’ scale devised by the University of Michigan shows, for example, that men are bigger tightwads than women, while younger people are more likely to be spendthrifts than
older people. The more educated a person is, the more likely they are to penny-pinch. Retailers use this scale to help predict spending patterns.
The power of financial personality
At one end of the scale, if your natural instincts are reckless and you do not save at all, you are likely to be heading for an impoverished retirement. However, at the other, there is also ‘reckless caution’, where people invest, but stick to cash or very
low risk investments. Of course, over-confidence is also a problem, encouraging people to speculate and – for the most part – lose money. These instincts can make a real difference to your wealth over time.
You cannot change your instincts, but you can manage them to ensure that the risks you take are appropriate. Taking the right risks over time is an important determinant of long-term wealth.
We have been working with behavioural finance specialist Greg Davies, of Oxford Risk, who has mapped out the key elements that make up a financial personality. We will feature more on these in the coming weeks on our Fineco website, but as an introduction,
these include:
1. Composure
Some people can keep their head when markets aren’t going their way, but others will panic. Both approaches have their limitations. Those who are inclined to panic will often buy and sell at the wrong moment, while those who have too much composure may be
too relaxed and fail to rebalance their portfolios when the environment changes.
Composure comes down to an investor’s emotional engagement with their investment in the short-term. Davies says: “There is a distinction between a person’s long-term cool calm and collected self, which they should be trying to invest for, and their short-term
self, which keeps getting in the way.”
2. Risk tolerance
Risk tolerance is about setting the destination of your investments, establishing clear parameters for a long-term investment portfolio, based on your goals, time horizons and wealth. Risk tolerance is readily measured and is unlikely to change significantly
over time. However, it can be derailed by problems of composure.
3. Experience
While elements such as composure and risk tolerance are hard-wired, experience can help you manage them and make better decisions. There is nothing like losing all your money in a speculative blue-sky stock to help you learn not to believe the tips of a
work colleague or investing through a dip in markets to learn the importance of balance in a portfolio. Self-reflection is important in drawing the right lessons from your experience – how did you act in specific environments? What should you have done differently?
4. Confidence
Financial confidence can help you to invest in the first place and can help you stay invested through tougher market conditions. However, there are times when confidence isn’t helpful, potentially pushing you into poor investment decisions and preventing
you from learning from your mistakes. Equally, it is easy to flip from excessive confidence to excessive pessimism when a decision doesn’t go your way. As such, understanding and managing your confidence levels is important.
Davies says that a proper assessment of these individual elements provides vital self-knowledge, which can help you build an appropriate portfolio for the long-term, and then not be distracted by the morning’s news.
He says: “Once I know I’m a low composure person, I can do things like use an adviser, so it rids me of the emotional burden, or set limits as to when I make investment decisions – only on weekends, for example, so I get an automatic cooling off period because
the markets aren’t open. Controlling your actions in the light of your composure level becomes easier.”
Oxford Risk has built a number of diagnostic tools based on psychometric testing that help investors understand their financial personality better. This understanding can help you shape the way you invest: it may stop you panic-selling when markets wobble,
or encourage you to be more responsive to shifting markets.