Money psychology: an introduction to financial personalities

Just as there are optimists and pessimists, introverts and extroverts, thinkers and doers, each of us has a financial personality that will shape our attitude to money: spending, saving and investing. The key is not to try and change your financial personality, but to be aware of it and work with it to get the best outcome for your long-term prosperity.

Perhaps you were taught to save up for treats, given a bank account from an early age, with pocket money dependent on chores. It could be that money was a source of conflict. You will also be influenced by whether your family was wealthy or if money seemed scarce.

Your financial personality will affect the way that you spend: the ‘spendthrift/tightwad’ scale devised by the University of Michigan shows, for example, that men are bigger tightwads than women, while younger people are more likely to be spendthrifts than older people. The more educated a person is, the more likely they are to be a tightwad. Retailers use this scale to help predict spending patterns.

At one end of the scale, if your natural instincts are reckless and you do not save at all, you are likely to be heading for an impoverished retirement. However, at the other, there is also ‘reckless caution’, where people invest, but stick to cash or very low risk investments. Of course, over-confidence is also a problem, encouraging people to speculate and – for the most part – lose money. These instincts can make a real difference to your wealth over time.

You cannot change your instincts, but you can manage them to ensure that the risks you take are appropriate. Taking the right risks over time is an important determinant of long-term wealth. Over the next few weeks, in collaboration with Greg Davies at Oxford Risk, we will explore the key elements that make up a financial personality. These include:

Composure – some people can keep their head when markets aren’t going their way, but others will panic. Both approaches have their limitations. Those who are inclined to panic will often buy and sell at the wrong moment, while those who have too much composure may be too relaxed and fail to rebalance their portfolios when the environment changes.

Composure comes down to an investor’s emotional engagement with their investment in the short-term. Davies says: “There is a distinction between a person’s long-term cool calm and collected self, which they should be trying to invest for, and their short-term self, which keeps getting in the way.”

Risk tolerance – Risk tolerance is about setting the destination of your investments, establishing clear parameters for a long-term investment portfolio, based on your goals, time horizons and wealth. Risk tolerance is readily measured and is unlikely to change significantly over time. However, it can be derailed by problems of composure.

Experience – While elements such as composure and risk tolerance are hard-wired, experience can help you manage them and make better decisions. There is nothing like losing all your money in a speculative blue-sky stock to help you learn not to believe the tips of your work colleague, or investing through a dip in markets to learn the importance of balance in a portfolio. Self-reflection is vitally important in drawing the right lessons from your experience – how did you act in specific environments? What should you have done differently?

Confidence – Financial confidence can help you to invest in the first place and can help you stay invested through tougher market conditions. However, there are times when confidence isn’t helpful, potentially pushing you into poor investment decisions and preventing you from learning from your mistakes. Equally, it is easy to flip from excessive confidence to excessive pessimism when a decision doesn’t go your way. As such, understanding and managing your confidence levels is important.

Davies says that a proper assessment of these individual elements provides vital self-knowledge, which can help you build an appropriate portfolio for the long-term, and then not be distracted by the morning’s news.

He says: “Once I know I’m a low composure person, I can do things like use an adviser, so it rids me of the emotional burden, or set limits as to when I make investment decisions – only on weekends, for example, so I get an automatic cooling off period because the markets aren’t open. Controlling your actions in the light of your composure level becomes easier.” Oxford Risk has built a number of diagnostic tools based on psychometric testing that help investors understand their financial personality better.

This understanding can help you shape the way you invest: it may stop you panic-selling when markets wobble, or encourage you to be more responsive to shifting markets. Understanding your financial personality should help you become wealthier in the long-term. However you approach investing Fineco offers a reliable platform experience with transparent pricing.