• / Free eNewsletters & Magazine
  • / My Account
Home>Practice Management>Practice Builder>Personality Type Theories and Investing

Related Content

  1. Videos
  2. Articles
  1. Social Security: Know the Rules on Spousal Benefits

    The decision about when to file for Social Security benefits is a complicated one, and it gets even more complex when two spouses are involved.

  2. These Growth Funds Aren't Laggards

    Although value funds have led the pack during this year's equity bull run, a handful of growth-oriented portfolios have held their own.

  3. Get a Handle on Your Portfolio

    Ahead of Portfolio Makeover Week, Morningstar's Christine Benz offers tips to alleviate common concerns over retirement readiness, inflation, allocation, and more.

  4. 6 Reasons to Check Your Expectations for the Economy

    Why Morningstar's Bob Johnson is not the most optimistic guy on the street.

Personality Type Theories and Investing

The fundamental characteristics of personality types are connected with the concept of the financial personality type.

Michael M. Pompian, 05/16/2013

This month's article is the fifth in a series called "Building Better Client Relationships by Understanding Investor Types." This series is intended to help advisors create great working relationships with their clients by taking a step back and understanding the type of person they are dealing with (from a financial perspective).

Individuals are different in the way they process information, vary in the way they behave when faced with a financial decision, and have different risk preferences, so it is essential that advisors interact with each client effectively. This often means that you must change the way you speak to different types of clients even though your advice may be similar across your client base.

Some advisors fail in their tasks not because they don't have technical knowledge of the markets, understand the strategies of investment managers, or have systems that can deliver the best methods of portfolio construction, but rather because they don't understand what is truly important to the client and how to communicate and interact in a way that is meaningful and effective.

As you know by now, I have dedicated a substantial amount of time promoting the benefits of behavioral finance research and making it accessible to large numbers of financial advisors. In my latest book, "Behavioral Finance and Investor Types," my primary objective was to simplify the practical application of behavioral finance by boiling down many of the complexities involved in diagnosing and treating behavioral biases into the simple concept of investor types, which I refer to as "behavioral investor types" or BITs. BITs are defined in large measure by the biases themselves and are categorized in a way that makes intuitive sense and can be easily understood.

In the last article, we defined belief perseverance biases and information processing biases, and we will now move to personality type theories. Although there are many different theories of personality, it is important to understand exactly what is meant by the term. Personality is made up of the characteristic patterns of thoughts, feelings, and behaviors that make a person unique. It arises from within the individual and remains fairly consistent throughout life.

To gain an appreciation for the foundation of the concept of a behavioral investor type, it is essential that we take some time to explore how personality types were developed. In this article, we will discuss some existing personality identification schemes, which will help put into perspective the behavioral investor type framework I will discuss in subsequent articles.

This article is intended to bridge the gap between mainstream personality theories and introduce the theory behind "financial personality types" or behavioral investor types, which combines elements of a number of personality theories. BITs are most strongly influenced by the Type Theories and are a classification scheme similar to Hippocrates' four original types, the Kiersey Types, and the Myers-Briggs Types.

Type Theories
Type theories take us all the way back to Ancient Greece, around 400 BC, to the work of Hippocrates. The great physician believed that people could be "typed" into four distinct categories named Melancholic, Sanguine, Choleric, and Phlegmatic, after the various bodily fluids that were then thought to influence personality. Each category was also linked to one of the four elements: fire, air, water, and earth, collectively referred to as the "humors." Today, Hippocrates' personality types are called: Guardians, Artisans, Idealists, and Rationalists.

> Guardians: Fact-oriented

> Artisans: Action-oriented

> Idealists: Ideal-oriented

> Rationalists: Theory-oriented

As you can see, these humors encompass the most basic, underlying characteristics of what we today refer to as "personality," but it is clear that no one's actions are entirely "rational" or "theory-based," and that no one is solely "action-oriented," but rather, most people are a combination of many of these humors in varying proportions. For example, your wife may be a "rationalist" and you may be more "action-oriented," but obviously neither of these characteristics constitutes your entire personality. This is also true of financial personalities, which we will discuss in much detail in future articles.

Personality type schemes tend to overgeneralize about personality traits (since people are rarely only one type of person), but they are a useful tool for organizing one's thoughts about how to compare one type of person versus another. Specific orientations or traits dominate each BIT. For example, the trait that dominates the Preserver BIT is an emphasis on limiting losses at the expense of gains. A term that could be used for this is a "loss averse" orientation. However, even the most aggressive investors sometimes find themselves being loss averse.

Some of the fundamental characteristics of personality are detailed below. These ideas are connected with the concept of financial personality. Once you understand in general terms how personality types are created, you will see how biases help to define each BIT.

1. Consistency: There is generally a recognizable order and regularity to behaviors. Essentially, people act in the same ways or similar ways in a variety of situations. This is also true with financial personality. When acting out their financial personalities, people will behave in repeatable patterns, akin to the person who is trying to lose weight and goes on yo-yo diets.

2. Biological and physiological traits: Personality is a psychological construct, but research suggests that it is also influenced by biological processes and needs. Although not entirely understood in the financial realm, biology can and does have an influence on financial behavior. For example, the need for items such as food, clothing, and other basics can influence a person's attitude toward these essential resources. Financial personality types incorporate these basic biological ideas but do not deal with them directly.

3. Impact behaviors and actions: Personality does not just influence how we move and respond in our environment; it also causes us to act in certain ways. This idea is the crux of why BITs were created. The only thing that really matters as it relates to financial personality is how a person behaves in relation to their money. Both practitioners and clients themselves can have ideas about how they might invest, but these ideas are essentially meaningless because no action has taken place. A concrete example of this is making an investment plan but then taking no action to implement it.

4. Multiple expressions: Personality is displayed in more than just behavior. It can also be seen in our thoughts, feelings, close relationships, and other social interactions. BITs are not intended to be clear-cut, unequivocal descriptions of each individual's investor personality. This would be too simplistic. People's behavior is simply influenced by too many factors. BITs were created to make basic categorization schemes for the purpose of comparison across a large number of individual investors.

Next Step
In the next article I will bring together the ideas presented here and the bias information provided earlier in the series. This will be a review of my original design for behavioral investor types as well as the upgrades and refinements that I have made to the proces in order to increase the usefulness for both advisors and investors.

The author is a freelance contributor to MorningstarAdvisor.com. The views expressed in this article may or may not reflect the views of Morningstar.

blog comments powered by Disqus
Upcoming Events
Conferences
Webinars

©2014 Morningstar Advisor. All right reserved.