Are investment preferences are correlated with personality? Arguments that physical risk-takers prefer equities have come and gone, and have largely been discredited.
Now two professors from Finland’s University of Oulu, Andrew Conlin and Jouko Miettunen, have managed to combine share ownership data with investors’ psychological-testing records in a study called “Personality Traits and Portfolio Tilts Towards Value and Size”.
The psychological profile gives the results from a test called the Temperament and Character Inventory, which, the authors state, “has been used extensively in the fields of medicine and psychiatry”. The TCI test measures four personality traits, from which the authors select two: novelty-seeking and reward-dependence.
“Novelty-seeking measures the degree to which one exhibits active behaviour in response to stimuli and actively seeks pleasure and reward when none is currently on offer.”
So people who score highly on novelty-seeking are easily bored. In contrast, those with patience receive low scores.
“Reward-dependence measures the degree to which one is emotional and responsive to social stimuli.”
People who score highly on reward-dependence care greatly about what others think. Their actions are guided by the social cues that they receive. Conversely, those with low scores are indifferent to public reactions.
Personality Traits
The authors then tinker with the sub-scores for the two traits to measure related traits. Their conclusions:
1) Extravagant people favour large-cap growth stocks.
2) Impulsive people favour small-cap growth stocks.
3) Sentimental people favour small-cap value stocks.
4) Social people favour small-cap stocks, with a modest value tilt.
In this context, extravagant means the propensity to spend/splurge, impulsive means the willingness to make decisions based on incomplete information, sentimentality means the tendency to be affected by emotional stimuli, and sociability means the propensity to join groups and feel attached to others.
The first two items make sense: extravagance and impulsiveness are aspects of a broader personality trait.
The second two items may well be correct, but sentimentality and sociability don’t fit into my growth/value framework. And I don’t have a framework for large/small preferences; if those investors who purchase large companies differ from those who like smaller firms, that's not been noticeable.
Faith and Hope
Growth-stock managers are optimists. They believe that the US is the greatest country in which to live, that now is the greatest of all times, and that their companies will do great things. They pay higher stock-price multiples for their purchases than do other investors, in exchange for getting something better. So, they must have faith; if they do not, they would cease to be growth-stock owners.
This faith leads to trust. Much more than value-stock managers, growth-style managers rely on what corporate executives tell them. Whether that makes them sociable or sentimental as those terms are used by the Personality Traits paper, I do not know, but it does make them extroverts.
Growth-stock managers tend to be extravagant – they do indeed spend more - and impulsive. Growth-stock owners invest in the future; they pay high prices now, to receive a high payoff later. They purchase hopes and dreams. They have no choice but to be impulsive, in the sense of making decisions based on incomplete information, because that is what buying the future entails. The task is not for those who require precision.
It would be a stretch to call value managers pessimists, in the attempt to make the contrast between them and growth-stock buyers symmetrical. Pessimists don’t buy stocks, for the most part. Rather, value investors are sceptics. They do believe that happy days will come again, thereby boosting the prices of their holdings, but they dampen their expectations. This is not necessarily the best of all possible worlds, and their companies are not necessarily great. Pretty good is enough.
Value managers invest looking backward, not forward. They do not know what the future will bring to their companies, but they do understand how similar investments have fared in the past. They are market historians, and are far, far likelier than growth-stock managers to follow the academic literature. Value investors are data-driven.
This means that they don’t place much faith in corporate executives. Why would they? If a company has been well managed, and operates in an attractive industry, it almost certainly will cost more than a value manager is willing to pay. Value investors hold businesses that have broken their promises, or which are dragged down by occupying an unprofitable sector. Perhaps those companies’ executives can offer useful guidance—but best not to take too much from them. Trust history’s odds instead.
Follow Your Instincts
The authors conclude by suggesting that their observed personality-based preferences can help to explain why value-style and smaller-company stocks have enjoyed higher returns, over time. Perhaps the existing asset-pricing models should be revised to accommodate these traits. It may even be possible to accomplish that task while retaining the assumption of rationality.
My conclusion is less theoretical. People are going to do what they wish to do. For most investors, the link between personality and investment style is immaterial—they will own a handful of broadly diversified funds, and thus their portfolios will not strongly tilt toward a particular style. Those of us who are more interested and involved as investors, however, will likely end up following our preferences.
John Rekenthaler has been researching the fund industry since 1988. He is a columnist for Morningstar.com. While Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.
