Investor Education: What’s your financial personality?

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on August 31, 2020 - September 06, 2020.
Investor Education: What’s your financial personality?
-A +A

When global markets plunged in March because of the pandemic, some investors made the decision to pull out of all their investments while others put in more money than they had budgeted for into the markets.

These decision-making tendencies can be explained by identifying one’s financial personality, an important factor to consider when building an investing strategy, according to Greg Davies, head of behavioural science for UK-based Oxford Risk Research & Analysts Ltd.

Founded in 2002 by academics specialising in decision science from Oxford University, the company builds behavioural finance tools to help maintain investors’ financial well-being. For instance, its Behavioural Alpha software includes a financial personality test that profiles investors and provides relevant advice.

The tool is being used by financial institutions globally, according to Davies. Recently, Standard Chartered released an “Investor Personality Study” using Oxford Risk’s tool on investors in Singapore, Hong Kong and Taiwan.

“Classical finance cares only about one bit of your personality, which is your long-term willingness to trade off risk and return. But we know that investor behaviour isn’t just about that. It’s also about the biases you have, your emotions and reactions to the market,” says Davies.

For instance, an investor can be willing to take high risks for higher returns in the long term. But that investor can also be plagued by anxiety in the short term, owing to fluctuations in the market. In that case, the adviser may need to assist that investor during bad times in the market.

“What if we can build a tool that measures the different dimensions of a person’s financial personality and really understand how one investor is different from another? Then we can build solutions that are more closely tailored to the investor’s personality,” Davies says.

Another financial personality dimension that the tool measures is the level of involvement. Some investors are more emotionally comfortable with their portfolios if they feel they are making the decisions, whereas others want an adviser or investment manager to bear the emotional burden of making investing decisions.

Meanwhile, investors who are very impulsive will need to put in place measures to prevent them from reacting to short-term movements in the market. Those who have low confidence in financial decision-making might need more handholding from advisers and regular investment communications.

“There are also measurable methods to find out whether people prefer active management or passive investments. We built this financial personality assessment tool based on data collected from thousands of experimental subjects. Investors will answer a questionnaire and see their scores on the different financial personality dimensions,” says Davies.

“My goal at Oxford Risk is to help people do better at something that they tend to do quite badly at, which is making investment and financial decisions. To achieve this goal, we need to understand investors’ personalities, what gets in the way of their making good decisions, and then build practical tools to help them make better decisions.”

The company released a free limited version of the test in March for the public. The Market Emergency Kit measures six key dimensions of one’s financial personality and provides recommendations based on the results.

Popularising behavioural finance

Davies got his start in this field in 2006, when he set up the behavioural economics and finance team in Barclays Bank in the UK. According to him, it was the first such team in the world, as behavioural finance then was just transitioning from an academic topic to being applied in commercial settings.

Behavioural finance studies the influence of psychology on the behaviour of investors or analysts, according to the Corporate Finance Institute.

Before this, Davies had completed his PhD in behavioural finance at the University of Cambridge. He stayed with Barclays for a decade as the head of behavioural-quant finance. His team developed frameworks and tools to improve financial behaviour, including financial personality assessments, goals-based investing solutions and portfolio optimisation techniques.

“If you build quantitative funds, you need to acknowledge who you are building them for and what they care about. So, quantitative and behavioural teams work very closely together. The real power of this collaboration comes from using a mix of data on investment and people,” says Davies.

Fortunately, his team was not laid off when the financial crisis hit in 2008, as it was in the midst of rolling out a new product, says Davies. After the crisis, the bank realised the importance of behavioural finance in helping investors make good decisions during bad times.

“That time reminds me of the Covid-19 pandemic. It’s in times of crisis that people really start to pay attention to why emotions and behavioural science matter in finance,” he says.

Davies and his business partners took over Oxford Risk in 2017, aiming to continue developing tools to help investors make better financial decisions.

“The problem we had in Barclays was that even though we found all these financial personality dimensions that we could measure, there was no existing theory of what to do with the results. So, we spent the next few years figuring out how to change portfolios accordingly and communicate with people after understanding their personalities,” says Davies.

“We have a lot of answers to this question now, and we can measure up to 15 dimensions of a person’s financial personality. For each dimension, we know a lot about what to suggest to a particular individual when building their portfolio, as well as what kind of products would be suitable for them and how to communicate with them.”

A digital and hyper personalised future

Oxford Risk works mainly with financial institutions and advisers and wealth managers. It chose this path instead of marketing directly to investors because financial advisers have more expertise on what kind of products could suit their clients, says Davies.

The company’s financial personality assessment tool has been rolled out in Barclays’ wealth management locations globally since 2007, he adds. Oxford Risks’ clients are mostly in the UK, although it also has clients in Singapore, South Africa and Europe.

Right now, the application of this tool is still rather straightforward: Advisers provide suggestions to investors based on the questionnaire results.

“We are working to plug these personality measures into a firm’s customer relationship or product selection systems, so the process can be completely automated and provide hyper personalised solutions to clients,” Davies says.

This capability goes well with the global trend of investors’ preference for digital platforms and passive investments. Davies believes Oxford Risk’s financial personality profiling tool can complement this trend.

“Over time, your financial circumstances change and that means you may need to tweak your portfolio, which also needs rebalancing periodically. You may tend to ignore this need until there is a crisis and you get very stressed, which is when you are likely to make bad decisions. Our tools will deter this, even on passive and automated investment platforms,” he says.

For example, an investor who is very worried during a downturn might be tempted to withdraw his investments from a robo-adviser platform. If the platform system knows the investor’s personality, it could prompt the investor not to make impulsive decisions during volatile markets.

“The robo-adviser could also observe whether you are logging into your portfolio more frequently than usual. Since it knows your personality, it will also observe the changes in your behaviour to detect whether you are getting stressed,” says Davies.

Another benefit of using this tool is that it can follow an investor along their journey.

“One of the problems of the advisory industry is that it is very frontloaded. There is less effort put into updating your portfolio as your circumstances change. A digital solution doesn’t just provide personalised services at the initial portfolio construction stage but also dynamically through your life stages [as you take the test periodically or as it monitors your behavioural changes],” says Davies.

Other than the financial personality assessment tool, Oxford Risk also develops tools for risk profiling, identifying portfolios as well as responsible and sustainable investing.

“We are also building tools that go beyond investing into financial well-being. Investing is just one end-point. There are also savings, debt management and insurance, all of which involve complex financial decisions,” Davies says.

Oxford Risk’s financial personality dimensions

Composure: How emotionally engaged is an investor with the present state of their investment journey? How affected are they by news or short-term market data?

An investor with low composure should avoid checking their investments too frequently. High-composure investors might need to be prompted to rebalance their portfolios.

Impulsivity: How likely are you to act based on emotional instincts when investing?

Impulsive investors should allow themselves to make investing decisions only during pre-set “decision windows”, which could be during the weekend when markets are closed and they have time to reflect.

Confidence: How comfortable or confident are you in making your own financial decisions?

An investor with a medium score is reasonably sure in their ability to make good financial choices but may occasionally feel uncertain during chaotic markets. Such investors are advised to set specific times to review their portfolios and trade instead of giving in to to knee-jerk reactions.

Familiarity: Are you comfortable only investing in things that are familiar to you?

Investors with high familiarity scores are likely to exhibit home bias when investing rather than holding a globally diversified portfolio. Advisers will need to help guide this kind of investors towards other asset classes.