How Your Personality Can Affect Your Portfolio

Can certain personality traits explain investors’ risk tolerance and investment decisions?

A forthcoming paper suggests it might. Specifically, the authors found that two personality traits—neuroticism and openness—significantly affect how investors perceive the economy, financial markets and their likelihood to buy stocks or stock funds, with those who are less neurotic and more open tending to have a higher allocation to equities.

While the authors primarily studied investors in the U.S., they also identified similar patterns among investors in Germany, Australia and China.

The Wall Street Journal spoke with two of the paper’s co-authors, Hongjun Yan, a professor of finance at DePaul University’s Driehaus College of Business, and Cameron Peng, an assistant professor of finance at the London School of Economics, about their findings. Zhengyang Jiang, an associate professor of finance at Northwestern University’s Kellogg School of Management, is the paper’s other co-author.

Here are edited excerpts of the conversation.

WSJ: How can psychology theories help to explain investor behaviour?

YAN: Investors often have very different portfolios. Traditionally, economists focus on risk aversion and market expectations, but in this paper we argue that well-known personality traits—extroversion, agreeableness, openness, conscientiousness and neuroticism—provide a new dimension to explain investors’ choices.

In the Winnie-the-Pooh stories, Tigger is always excited and optimistic while Eeyore is always down and pessimistic. You might expect their investment portfolios to look very different and reflect their overall outlook.

WSJ:How did you study this topic?

PENG: We collaborated with the American Association of Individual Investors, administering a survey to over 3,000 of its members. We collected information on their personality traits, market expectations, and investment decisions. The AAII sample is predominantly wealthy, white, older men. And when they make investment decisions, they are usually quite big, involving hundreds of thousands or even millions of dollars. Their actions can have a real impact on the market.

WSJ:What did you find?

YAN: We found that neuroticism and openness are correlated with investors’ beliefs about the market and their likelihood to buy equities. We were surprised that agreeableness wasn’t important when it comes to investment beliefs or decisions since other researchers have found that agreeableness tends to be correlated with other economic outcomes, like success in negotiating wages.

WSJ: How does neuroticism affect investors’ decisions?

YAN: Someone who is more neurotic has a very different outlook than someone who is not in terms of stock-market expectation. For example, an investor ranking in the middle of the [neurotic] scale might expect an annual stock-market premium of about 6%. But investors at the top of the scale are likely to only expect a 4% stock-market premium, while investors at the bottom of the neuroticism scale are likely to expect an 8% stock-market premium.

PENG: Neuroticism also affected how respondents invested their money in their actual accounts. More neurotic investors were less likely to own equities. Very neurotic investors invested about 56% of their portfolio in equities, while investors who weren’t neurotic invested about 64% of their portfolio in equities.

WSJ:How does openness affect investors’ decisions?

PENG: Investors ranking high for openness were more likely to entertain the possibility of extreme events, like a market crash or a run—really any scenario when the market goes up or down by more than 20%.

Investors who were very open were somewhat more likely to take risks by buying equities. Specifically, investors who were the most open were 3 percentage points more likely to own more equities than investors who weren’t. They had about 62% of their portfolio in equities, while investors who were less open had about 59% of their portfolio in equities.

WSJ: What did you find when you looked at data from other countries?

YAN: We find that neuroticism and openness affect market perceptions and decisions fairly consistently across different data sets. That’s quite remarkable considering the culture and investing environment in each country is very different.

WSJ:What are the study’s implications?

YAN: Personality traits may shape investors’ decisions in ways that many economists have yet to seriously consider. Our research, for instance, also suggests more extroverted and more neurotic investors’ investment choices could be highly influenced by social interactions, or what their friends or colleagues are doing. That insight goes beyond economists’ traditional framework, which focuses on risk tolerance and market expectations, and could help researchers better explain investor behaviour.

PENG: Large asset-management firms or financial planners could spend time getting to know their clients’ personalities and use those insights when they make investment recommendations. Maybe they could encourage investors who tend to be neurotic to be a little less pessimistic.

Could a recession be the best time to launch a tech startup?

A recent study suggests that is the case. The authors found that tech startups that began operations during the 2007-09 recession—and received their first patent in that time—tended to last longer than tech startups founded a few years before or after. And those recession-era companies also tended to be more innovative than the rest.

“The effect of macroeconomic trends is not always intuitive,” says Daniel Bias , an assistant professor of finance at Vanderbilt University’s Owen Graduate School of Management, who co-wrote the paper with Alexander Ljungqvist, Stefan Persson Family Chair in Entrepreneurial Finance at the Stockholm School of Economics.

Drawing on data from the U.S. Patent and Trademark Office, the authors examined a sample of 6,946 tech startups that launched and received their first patent approval between 2002 and 2012.

One group—about 5,734 companies—launched and got their patent outside of the 2007-09 recession. Of those, about 70% made it to their seventh year. But the startups that launched and got their first patent during the recession—about 1,212 companies—were 12% more likely to be in business in their seventh year.

These recession-era firms were also more likely to file a novel and influential patent after their first one. (That is, a patent the researchers determined was dissimilar to patents in the same niche that came before it, but similar to ones that came after it.)

So, why did these recession-era firms outperform their peers? Labor markets played a big role.

A widespread lack of available jobs meant that the startups were able to land more productive and innovative employees, especially in their research and development groups, and then hold on to them. More important, the tight labor markets also meant that the founding inventors—the people named on the very first patent—were more likely to stick around rather than try for opportunities elsewhere.

For startups started during the 2007-09 recession, founding inventors were 25 percentage points less likely to leave their company within the first three years. On average, about 43% of founding inventors in the entire sample left their startup within the first three years.

“Our study really highlights the importance of labor retention for young innovative startups. Retaining founding inventors cannot only help them survive, but also thrive,” Bias says.

How Your Personality Can Affect Your Portfolio

Neuroticism and openness, in particular, are closely linked to investors’ willingness to buy stocks

A study suggests that when jobs are hard to come by, the best workers are more available—and stay longer