By Jason Zweig | Feb. 22, 2012 8:00 am ET
Image credit: “Gemini,” Book of Hours (Milan, ca. 1470-1480), The Morgan Library
Why are some people more prone to stupid financial behavior than others?
Several of the most common and costly mistakes that investors make appear to be encoded in our genes.
So argues a new research paper from two finance professors, Henrik Cronqvist of Claremont McKenna College and Stephan Siegel of the W.P. Carey School of Business at Arizona State University.
Cronqvist and Siegel based their study on two sets of remarkable data.
In Sweden, until recently, the government collected details about each holding in taxpayers’ investment portfolios. Cronqvist and Siegel could thus track the investment portfolios of individual Swedes, as well as any of their sales of securities, between 1999 and 2007. (None of the investors’ names were disclosed to the researchers.)
What’s more, the Swedish government enters all twins in a national register at birth. Cronqvist and Siegel identified more than 30,000 twins with investment portfolios – including more than 9,200 identical twins – and then studied how much their investing behavior varied. Bear in mind that identical twins are genetically a perfect match, while fraternal twins share similar but not identical genetic profiles; the researchers also compared twins against a random sample of nontwins as an experimental control.
The intuition is obvious: If thousands of people who are genetically identical exhibit the same behavior more strongly than thousands of nonidentical people do, then it’s plausible to attribute the variation in behavior to their genetic makeup.
Cronqvist and Siegel studied five prevalent investing mistakes or “biases”:
- Inadequate diversification (measured as a preference for investments based in Sweden)
- Excessive trading
- The reluctance to sell at a loss
- Chasing hot past performance
- Trying to get rich quick.
Cronqvist and Siegel found, across the twins in their sample, that genetic variation explained between one-quarter and nearly one-half of the extent to which investors suffered from these biases. Inadequate diversification scored the highest, with genetic effects explaining 45.3% of the variation across investors. At the low end, 25.7% of the degree to which investors traded too much was explained by their genetic variation.
Of course,we aren’t just abject slaves to our double helix when we invest. As intriguing as these new data are, they still explain less than half of what makes investors tick.
Experience is hugely important. Our childhood experiences of wealth or deprivation shape our adult attitudes toward money, and our past mistakes of omission and commission haunt us as investors. Environment also shapes our financial decisions: Investors who are conservative in isolation can become aggressive if they are surrounded by bragging risk-takers, and momentary swings in emotion can wreak havoc on long-term financial plans.
But there’s good reason why Wall Street’s marketers invoke urgency, familiarity, temptation and a lottery mentality when they’re selling products and services. Millions of investors are probably born with the genetic predisposition to underdiversify, trade too much, chase hot returns and bet on longshots.
As I’ve written before, it takes years of deliberate effort for investors to become even partially effective at counteracting their own genetic biases.
This new research hammers home how vital it is for us all to realize, in the immortal words of Benjamin Graham, that “the investor’s chief problem – and even his worst enemy – is likely to be himself.”
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Source: Total Return blog, WSJ.com, http://on.wsj.com/167ZCks