Behavioural Finance: Exploring Wealth Personalities

The way we think about investing is changing; we believe that success can’t be understood with just a set of numbers. A discovery process using the cutting-edge field of behavioural finance can help advisors to better understand their clients and what influences their wealth decisions.

The way we think about investing is changing; we believe that success can’t be understood with just a set of numbers.  A discovery process using the cutting-edge field of behavioural finance can help advisors to better understand their clients and what influences their wealth decisionsi.

CHANGING ECONOMIC THEORY

Economists once believed that investors, given the right information, acted rationally in pursuit of their own interests.  With the help of behavioural economics, we now know that this is an oversimplification.

Many investment decisions can be instinctive, with no basis in logic, and many more may only make sense once you understand the unique perspective underlying that decision.

Behavioural Economics is a method of economic analysis that applies the psychology of human behaviour to explain economic decision-making.  Lessons from behavioural economics can be used to create environments that nudge people toward wiser decisions and healthier livesii

Traditional economics assumes that individuals are rational decision makers, who are consistent in accurately weighing the costs and benefits of their decisions. As Psychologist and Economist Daniel Kahneman stated, “it seems that traditional economics and behavioral economics are describing two different speciesiii."

When we think about investing we must consider our 'blind spots'; those areas that impact our ability to appropriately assess the costs and benefits of a decision.  Knowing and understanding how these blind spots impact wealth decisions is an important step in building an investment and wealth plan that address our needs and goals.  An appropriate discovery process using behavioural finance can aid in uncovering these blind spots.

COMMON BLIND SPOTS

Framing Effect

The tendency to respond to the same problem differently, depending on how it is presented.

Is this you?

You may respond differently to portfolio performance presented as a % rather than a dollar figure.

Familiarity

The tendency to over-invest in what you are familiar with.

Is this you?

You may have a tendency to invest more heavily in companies or industries you know (e.g. companies or industries in which you work). This could lead to an overconcentration in a specific sector.

Sensitivity to Noise

'Noise' is recent information that can tempt you to second guess your established investment strategies.

Is this you?

You may be tempted to make reactionary changes to your portfolio at inopportune times based on noise in the media. These decisions based on noise may negatively impact your portfolio.

Loss Aversion

The tendency to feel losses more strongly than gains.

Is this you?

If your portfolio lost 10% in value, this might generate a stronger emotional response than a 10% gain in value.

Short Term Focus

The tendency to value a reward that arrives sooner and discount a reward that arrives later.

Is this you?

You may have a hard time visualizing retirement income and expenses or have difficulty saving for a future goal.

Overconfidence

The tendency to overestimate your own investment ability.

Is this you?

You may engage in higher trading activity than the average person, which has been shown to lead to lower returns.

TD Wealth employs a discovery process driven by a Five Factor Model of Personality to chart Wealth Personalities - conscientiousness, agreeableness, reactiveness, extraversion and openness - to uncover financial blind spots.  

BEHAVIOURAL FINANCE AT WORK

A quantitative study was recently completed by TD Wealth focused on the Five Factor Model of Personality. This study produced a number of interesting findings, which can be accessed through the report published online.  In the interest of time, I will focus on one cohort for this piece.

Looking at the findings of investors across varying ages:

Those aged 18 to 34 were questioning, 'in the moment', and quick to react.

The traits commonly associated with this younger group are also the ones most likely to stand in the way of long-term and short-term thinking. With a longer runway to retirement, younger investors can be better positioned to take on risk; however, their tendency to react hastily to market events may prevent them from reaping the rewards that may come from weathering a higher-risk strategy.

Those aged 35 to 54 were questioning, reflective and calm under pressure.

Only 21% of middle-aged investors reported a high degree of satisfaction with retirement readiness, a low number compared to other cohorts. Could this be that middle-aged investors – who may be dealing with busy careers, young children and elderly parents – are more likely to put their retirement ambitions on the back burner?  Time management is important to these individuals and communications should be efficient and relevant.

While those aged 55 and up were amenable and confident.

A greater percentage of older investors in the study were financially confident. This may be a result of having lived through numerous market ups and downs, perhaps making them more comfortable in navigating financial issues. These individuals should ensure they do not get too comfortable as vigilance to the economic environment is important.

LOOKING FORWARD

Behavioural Finance can play a significant role in helping an investor to understand their clients more fully and also to help those clients understand themselves at a deeper level.  

In an increasingly volatile market environment, understanding your wealth personality helps both you and your advisor to develop a path that is appropriate to your needs, consistent with your expectations and can guide you through various stages of life.


iThis article includes excerpts from TD Wealth's Behavioural Finance Industry Report: Exploring Wealth Personality (2019)
iiHeshmany Shahram, Ph.D. (2017) What is Behavioral Economics?: Helping people lead healthier and happier lives
iiiKahneman Daniel (2011) Thinking, Fast and Slow, New York: Farrar, Straus and Giroux

TD Wealth represents the products and services offered by TD Waterhouse Canada Inc., TD Waterhouse Private Investment Counsel Inc., TD Wealth Private Banking (offered by The Toronto-Dominion Bank) and TD Wealth Private Trust (offered by The Canada Trust Company).

About the Author

Julie Fitzpatrick, CPA, CA

Investment Advisor, TD Wealth Management
Julie Fitzpatrick is an Investment Advisor with TD Wealth Management in Saint John. She obtained her Chartered Accountant (CA) designation in 2012, placing on the David Hope Honour Roll, and holds a Bachelor's degree in Business from the University of New Brunswick Saint John, graduating with the Lieutenant-Governor's medal for distinction in scholarship. At TD Wealth, Julie works with clients to prepare personalized and comprehensive wealth and investment plans to help comfortably meet their goals.