The Big Five and Behavioral Finance
Contributor Michael Pompian introduces a new series that examines the relationship between the "Big Five" personality traits and the behavioral biases of investors.
My earliest work in the field of behavioral finance in the late 1990s examined the correlations between investor behavior biases and the Myers-Briggs Type Indicator, or MBTI. I found some statistically significant relationships between some of the Myers-Briggs traits, such as introversion and extroversion, and behavioral biases, such as loss aversion. (You can find that paper on my website, Sunpointe Investments, if you are interested.)
Over the years, I have followed a debate between the effectiveness of the Myers-Briggs test versus another widely used personality test, the Big Five. More recently, the debate has intensified. I decided to conduct a study of the the Big Five. Specifically, I studied 120 investors, examining the relationship between the Big Five and investor biases. This is the first article in a new series examining the traits and the findings of the study.
Before we dig into the results, let's first learn more about the Big Five and the MBTI. In some ways, the Big Five is an easier personality test to work with because of its simplicity. On the other hand, one still needs to diagnose and understand which traits an investor has in order to best extract meaningful information--and in that respect, the Big Five and the MBTI are quite similar. Either way, understanding the underlying personalities of your clients can lead to better advice and outcomes.
Understanding the Differences As a student of personality tests and, obviously, behavioral finance, I have examined the two major models dominating this field--the Big Five and the MBTI. As noted, there is an ongoing debate about which one is better.
The MBTI is a personality inventory test based on a typology introduced by psychiatrist Carl Jung in the late 1800s/early 1900s. The MBTI questionnaire, first published in 1943, was originally developed by Katharine Cook Briggs and her daughter Isabel Briggs Myers. Katharine Briggs was inspired to start researching personality type theory when she first met her daughter's future husband, Clarence Myers. The MBTI organizes people by their attitudes toward their inner and outer world, called extroversion and introversion, and by their cognitive tendencies, which are either perceiving or judging. Perceiving preferences describe how one takes in information either through one's senses, called sensation, or intuiting information, which is called intuition. Judging preferences describe how we process information using either logic, called thinking, or emotion, called feeling. The last category, which breaks down into judging and perceiving, refers to whether one uses judgment or perception when interacting with people and events.
Exhibit 1: MBTI Categories
The "Big Five" model is a classification scheme that attempts to cover the major aspects of one's personality. In the 1940s, Raymond Cattell developed a 16-item inventory of personality traits and created the Sixteen Personality Factor Questionnaire, or 16PF, to measure these traits. Robert McCrae and Paul Costa later developed the Five-Factor Model, or FFM, which describes personality in terms of five broad factors or traits. The five traits are: extraversion, neuroticism, conscientiousness, agreeableness, and openness. The Big Five doesn't attempt to understand what people are thinking; it focuses on preferences of actual behavior. For example, the following is a question about openness: "Do you like trying new things or do you have a routine you stick to?" As you can see, the Big Five is more about behavioral tendencies than it is about cognitive traits.
Exhibit 2: The Big Five Traits
Source: American Psychological Association.
In terms of application, the MBTI is commonly used in more practical pursuits, such as business and education, while the Big Five is a bigger player in academic research. The MBTI is considered more of a "soft" science versus being more "black and white." The Big Five, meanwhile, is considered more scientific, since it is simply a way of sorting traits. For example, it can measure how one action correlates with another, such as learning that people who rate high on conscientiousness make their bed more often versus people who rate highly on other traits. The MBTI divides people into types, whereas the Big Five measures traits on a dimensional scale. For our purposes, we will be examining if people who have a certain trait, such as agreeableness, are prone to certain investor biases.
To better understand the Big Five, you may want to take the test yourself.