What shapes our investment decisions?
Given a choice, most investors would settle for lower returns with less or no volatility than investment with high fluctuating higher returns. This is partly to do with our risk averseness and crave for order and stability in any investment plan. While most investment avenues are structured, rule-based and rational; our investment choices, however, are emotional if not irrational.
This is the reason why we tend to witness the investment doing better than our participation in it i.e. a fund might perform better than an individual's investment in that fund.
The success of one's investment does not depend upon how the market reacts to news but how one would react to the news matters most. So, what are the reasons for each of us to act differently to the same market data.
What keeps us staying invested in a particular stock when all else are dumping it and avoid investing in the same stock when others find it attractive. How we interpret the same data points variedly is a point of contention.
Amir Barnea and his team analysed the data of Swedish Twin Registry (STR) to assess the importance of various factors that explain the variation in equity holdings of the test group.
STR is the largest database of twins and multiplets in the world, established in 1960 and based out of Stockholm. It has data of virtually every twin born in Sweden since 1886 with totaling to 194,000 twins.
The study compares the psychological traits of both identical (monozygotic) and unidentical (dizygotic/fraternal) twins where the latter is similar to any other siblings while the former have an identical genetic code. The study thus concentrates on impact of genes and also the influence of shared environment (growing up) on the human behaviour.
The wealth of this data helped researchers understand how personality traits, personal skills and education has impacted on their overall growth.
In some extreme cases where the identical twins were separated at birth and adopted by different parents, the data has collected all through their lifetime on how they fared with their incomes and investments highlighting the contribution of surroundings in shaping up the investment decision making despite similar personality traits.
The study thus highlighted three distinct factors that influences the investment decision making: Genetic Effect, Shared Environment Effect and Individual-specific error.
The research surprisingly throws that about 40 per cent of the variation in equity holdings (riskiness) is linked to the genes for young investors (below 30). And the genetic make-up influenced about 20 per cent as the respondents aged (up to 55) with time and remained around that level all throughout (age of 80 and upwards).
Despite the advanced genetic tests to determine possible diseases one might contract during their lifetime; a simple analysis of family history achieves similar results.
Likewise, it's observed that risk-taking abilities of the respondents were predominantly defined by overall risk tolerance displayed by the family or parents. Simply put, if family members were in relatively stable and secure jobs or workplaces, the genetic behaviour displayed by the offspring were more likely risk averse and wise verse.
The second prime factor of the findings reveal the impact of Shared Environment the twins grew. Here again, the younger investors were influenced to some extent by cultural background they grew up in.
Studies have shown that individuals in more individualistic societies tend to be more risk averse than those of in collectivist societies where they have support through extended family.
The data from the research found that individual experiences form the crucial source of our behaviour, and the investment decisions made during formative years i.e. between ages 16 and 25 tend to have a lasting impression on to the future.
The attitude towards recession and inflation are largely formed due to memories of these during the formative ages.
That leaves us with individual-specific errors essentially derives the investment decision making. So, it's the choices we make though influenced by other factors would define the investment returns. These errors could be further nullified by opting for qualified financial advice.
(The author is a co-founder of "Wealocity", a wealth management firm and could be reached at knk@wealocity.com)