Anatomy of an Investor
Personality, Age and Background Influence Your Investment Decisions More Than You Might Think, Finance Professor Says
by Tracy Mueller
Theories on how to play the stock market abound. Buy low, buy companies whose leadership you admire, invest in organizations that reflect your personal values. And don't count out the ever-popular strategy of throwing darts at the newspaper's financial pages.
Every investor hopes he or she has figured out how to beat the system and turn a huge profit. "Perhaps my portfolio is a perfect blend of stocks chosen at the ideal time to bring in enormous returns," they say wistfully to themselves.
But what if your strategy isn't determined as much by shrewd analysis (or quality dart throws) as by where you live? Or how old you are? Or if you bought a lottery ticket at the gas station yesterday?
New research by Alok Kumar, assistant professor of finance, shows these factors - geography, age and even whether or not you gamble - play a key role in how individual investors choose stocks. Kumar and Federal Reserve Board economist George Korniotis studied the demographics and financial transactions of 70,000 anonymous investors and found a person's behavior in the stock market can be traced back directly to his or her personality and biography.
"There's no reason to believe that suddenly when you start to invest, you become a different person," Kumar says.
Sounds simple enough, but Kumar's research is part of a burgeoning behavioral finance field that is changing the way experts think about financial systems. In the past, economists viewed the market as one massive entity, driven by people motivated solely by the desire to maximize wealth, Kumar says.
But behavioral finance draws on principles from psychology and sociology. This relatively new field asserts that the market consists of thousands of individual players whose distinct backgrounds, beliefs, goals and fears influence their decisions - sometimes to the detriment of their wealth and the health of the market.
Perhaps there is no better proof of this than the recent financial crisis.
"Traditional finance says the behavior of individual investors is cancelled out when you look at the entire market," Kumar explains. "But the subprime mortgage collapse is a perfect example of the dramatic effect even small entities can have on the market. It shows that often those deviations from expected behavior are not random, but systematic. Many individuals make similar mistakes at the same time, and thus the effect of those mistakes is amplified."
Rolling the Dice
Evidence of counter-productive stock market behavior is outlined in Kumar's study, "Who Gambles in the Stock Market?" (forthcoming in the Journal of Finance). He found that the socioeconomic characteristics of people who play state lotteries are very similar to investors who pick stocks that have a lottery quality - high risk with a potential for high return.
But just like playing the lottery, gambling in the stock market usually does not pay off.
"We found that people who took risks in the stock market typically earned 2 to 3 percent less than other investors," Kumar says.
Kumar also found that people tend to purchase lottery-type stocks more often in a down economy. What's more, investors who live in regions with a higher concentration of Catholics have a stronger preference for lottery-type stocks, while those in Protestant regions are less drawn to them - a pattern that mirrors ticket-purchasing trends in state lotteries. Those choices generally align with other gambling behavior by the two groups, says Kumar.
