Ever wonder how much control you have over your investing tendencies? Finance professors Henrik Cronqvist of Claremont McKenna College and Stephan Siegel of the University of Washington have studied the role genetics play in how we invest. For their research (which you can download here), Cronqvist and Siegel used data from the Swedish Twin Registry--the world's largest twins database--and matched it up with taxpayer data from Sweden, which, until 2007, required disclosure of investment holdings. By comparing investing habits of identical twins, who share 100% of their genes, with those of fraternal twins, who share 50% of their genes on average, Cronqvist and Siegel arrived at some interesting findings. They discussed their research with Morningstar.
One of the conclusions you arrive at is that education cannot overcome genetic predisposition to invest a certain way. Does this mean we all are destined to invest in whatever way is hard-wired into us?
We cannot say why education doesn't reduce genetic investment biases. At this stage, our goal was simply to examine if education is a moderator that reduces the effect of genetic predispositions with which we're born. Apparently it doesn't. The investment behavior of someone with a doctorate in, say, physics seems to be influenced as much by his/her genes as your barber. Some of our results about financial occupation/experience indeed suggest that it's practical experience that matters. Note, by the way, that our findings differ from what researchers have found with respect to education and health outcomes, where it has been documented that higher education reduces the degree to which genetic-based health problems develop in an individual.
You've identified various investing biases that seem to be strongly linked to genetics, such as a tendency to be insufficiently diversified, a reluctance to realise losses, and performance-chasing. Do any of these traits appear to have stronger genetic links than others?
Our results suggest that some biases--for example, the home bias [the tendency among investors to favour domestic stocks over foreign stocks]--are explained by genetic factors to a larger extent than some of the others like excessive trading. At this point we don't have a strong theory for why one bias might be more genetic than another. But we agree with you that this would be a very interesting question for us to study more in the future.
The study alludes to how tendencies we humans have acquired through hundreds of thousands of years of natural selection might work for or against us when it comes to investing. Can you provide examples?
Many of the biases we study are perfectly reasonable heuristics, or methods of investigation, for lots of nonfinancial decisions. That's probably why they have survived evolution over hundreds of thousands of years. An example we like is past performance. For most purchases we do in life, such as purchasing a new BMW, basing that decision on past performance of the product is a very reasonable decision heuristic, and it will generally steer us right. So we believe that people tend to apply those heuristics also in the domain of personal finance, whether those heuristics are valid there. An example of this is the tendency to purchase stocks with superior past performance and not realise that specific performance may not persist. This contrasts with the persistence in the performance/quality of a BMW in 2012 compared with 2010. To show how powerful and pervasive these biases can be is a new finding of our paper.
I (Henrik) once read someone concluding that human preferences would probably have looked differently if humans evolved in a casino. One could take this logic and conclude that humans didn't evolve on the floor of the New York Stock Exchange. If they did, perhaps we would not exhibit some of these biases in the finance domain. But we have evolved in a much broader setting than finance, and sometimes what is a reasonable heuristic and decision rule is not an appropriate one in another domain.
Your study uses identical twins as the basis for an examination of investing styles. For those of us without a twin, does taking note of a sibling's or parent's investment style--and mistakes--provide a clue as to good/bad habits we might engage in ourselves?
Fraternal twins and any other nonidentical twin siblings share on average 50% of their genes. Note that we say on average. So some fraternal twins are more similar than others. But it is correct that even non-identical-twin siblings share genes, and thus may display more similarity with respect to investment biases than, say, you and the person in the office next to yours.
Has your research caused you to re-examine your own behavior as an investor? What changes, if any, have you made as a result of your findings?
Cronqvist: Not really. For several of the behaviors, however, I see clear similarities between myself, my dad, and my brother. But the similarity is not perfect and not on all dimensions as we would expect given our conclusion that investment behaviors are explained to a significant extent (up to 50%) by genetics, but not perfectly so.
Siegel: Although I see similarities with my parents and siblings, I also see that having studied finance for many years leads me to prefer passively managed index funds. However, my father very much prefers to select individual stocks for his portfolio and my sister invests mainly in actively managed funds.
This article was originally published April 2012 on Morningstar.com, a sister site to Morningstar.co.uk.
