Paul Nixon, Head of Behavioural Finances at Momentum Investments
Famous 19th century American poet, Emily Dickinson, once said, “Behaviour is what a man does, not what he thinks, feels, or believes”. It is this notion that pervades throughout human history as our actions determine our outcomes, which are ultimately driven by our behaviour. When it comes to seemingly analytical and objective financial decisions like how to invest your money, behaviour tends to come at a price.
Head of Behavioural Finance at Momentum Investments, Paul Nixon, says behaviour often comes with a ‘tax’ in the investment world. “This is particularly true for fear and greed, which both represent strong emotions that people link to perceptions of danger and opportunity. How you feel, and how you behave, tend to impact how you invest.”
This was revealed in Momentum Investments’ recent Sci-Fi report that measured investor behavioural patterns on the Momentum Wealth platform for the 2021 period. By analysing the behaviour of investors during this period, it was found that active investors (defined as investors performing switch transactions) increased by 80% and the number of switches by 50% to a record-high level of 27 994.
Using unsupervised machine learning algorithms, Nixon says Momentum Investments was able to identify switching behaviour patterns over time. While investors may have stable attitudes to risk (they either like it or they don’t) or risk preferences, ultimately decision-making behaviour in risky conditions was also affected by the ‘label’ attached to the situation and the individuals experience of similar decisions as being profitable or otherwise in the short run. This affects their perception of risk and during market turbulence (as was experienced during the global pandemic) investors will perceive there to be a great deal more risk in markets, which may result in them de-risking their investments.
“We identified four investment behaviour archetypes that tend to explain the actions made by investors in particular situations,” says Nixon. It is highly possible for an investor to display characteristics of one archetype and then become another archetype in a separate situation. This reflects the tension that arises between our general attitudes towards risk and how these can become distorted during market volatility. There is, however, evidence that investor attitudes are stable in general. In more situations than not, an investor will perform investment switches that are aligned with their archetype or risk preferences, but as risk perception in the short-term ebbs and flows, investors may occasionally behave like one of the other archetypes.”
The four identified investment behaviour archetypes include:
You are more risk-tolerant and clearly set on chasing past investment performance. You generally exude confidence and are influenced less by financial advice and more by greed (i.e. relative outperformance of others).
You have a lower risk appetite but don’t avoid risk altogether. You are very sensitive to downside risk and are likely to act out of fear during market turbulence. This means you are prone to switching to worse performing investments usually associated with de-risking your portfolio.
You have a lower risk appetite and have a preference to avoid risk altogether. You retain generally conservative portfolios over time. When you do make investment switches they are more likely to be risk-neutral (neither increasing nor decreasing the overall risk of the portfolio).
You have the greatest propensity to perform investment switches and your defining behaviour pattern is being greedy when others are greedy and fearful when others are fearful.
Nixon says these investor behaviour archetypes provide a glimpse into how behaviour can affect our financial success in investments and beyond. “Our preferences determine our actions and therefore leads us on a path. Whether that is a path to success is up to us and our ability to recognise the impact of our behaviour. To get real about success, it is vital to determine which archetype you are” concludes Nixon.