– New global report reveals link between use of financial self-control strategies and wealth
– Emotions tempt us to buy high, sell low; can cost investors up to 20% in returns over 10 years
– US wealthy more satisfied with their financial situation, ranking 5th among 20 countries surveyed
Despite their wealth, 41% of high-net worth individuals wish they had more self-control over their financial behavior, says the latest report in the Barclays Wealth Insights series. Interestingly, a need for increased financial discipline is likely to be felt most by those at the wealthiest end of the scale $15 million+ (10 million pounds Sterling), where 45% of respondents wish they had more self-control. This is in spite of the report showing that those who desire greater financial discipline are also less likely to be satisfied with their financial situation.
The report, Risk and Rules: The Role of Control in Financial Decision Making, is based on a global survey of more than 2,000 high-net worth individuals in 20 countries, and provides an in-depth view of wealthy investors from a behavioral finance perspective. The report considers the different financial personality traits amongst wealthy investors, and the different self-imposed rules and strategies that they put in place to deal with these traits. Emotional trading can potentially cost investors up to 20% in returns over a decade,(1) and the report shows that investors who frequently use financial self-discipline strategies (e.g. spending out income, never out of capital, or avoiding frequent examination of a portfolio to help resist temptation to trade on short term market trends and stray from a long-term investment strategy) are on average 12% wealthier than those who do not.
Globally, respondents in Asia-Pacific have the greatest desire for financial discipline, particularly in Taiwan (#1) and Hong Kong (#2). In contrast, developed markets show the least desire for financial discipline, as illustrated by respondents in Spain (#1), Australia (#2) and the US (#3).
When compared to the rest of the world, the wealthy in the US are more satisfied with their financial situation, ranking fifth among investors from the 20 countries surveyed. Despite this satisfaction, 29% still wish they could take a more disciplined approach to their financial behavior. Regionally among US investors, those in the Midwest and West demonstrate the highest levels of satisfaction with their financial situation (84% and 77% respectively), while those in the Northeast have the lowest (75%).
The report reveals a prevalent mistake of ’emotional trading,’ which can tempt investors to buy high and sell low, leading to the Trading Paradox. Worldwide, one third of those polled (32%) believe that to obtain a high return in investing, it is necessary to trade frequently; paradoxically, the very same investors who identify themselves as believing frequent trading is prerequisite for high returns are much more likely to say that they trade too much. In total, almost half (46%) of respondents who believe it is necessary to trade often to do well also believe that emotions force them to do this.
Interestingly, high net worth investors in the US seem to have eluded the pitfall of ’emotional trading’ by taking a more rational approach to investing. US investors are more likely to adopt a buy and hold strategy (23%), recognizing that frequent trading doesn’t necessarily equate to higher returns. Just 15% of US respondents believe that to do well in the financial markets, it is necessary to buy and sell often. Only 8% of wealthy US investors surveyed felt that they trade investments more than they should.
In order to understand investment behavior and the pitfalls that investors may be prone to, the report considers three personality dimensions: Risk Tolerance, Composure (tendency to heightened emotions) and Promotion vs. Prevention (focus on making good things happen vs. preventing bad things from happening).
Falling victim to a trading paradox can potentially lead to investors becoming unable to control how often they trade, and even, possibly, becoming addicted to trading. Investors with a combination of high risk tolerance, low composure (marked tendency to heightened emotions and stress), a high prevention focus (very focused on preventing bad things from happening) turned out to be most likely to fall victim to this paradox.
Regionally in the US, investors in the South demonstrate the highest incidence of the trading paradox while those in the Northeast demonstrate the lowest. Almost a quarter (24%) of Southern investors are likely to try to strategically time the market; 17% think trading often is necessary to do well but believe they trade too much (11%). By contrast, only a fifth of investors (20%) in the Northeast say they try to strategically time the market; only 13% perceive the need to trade often or only 6% believe that they trade too much.
Female investors trade less, earn more
When it comes to disparities among male and female investors, the report has identified several robust differences. Women reported a greater desire for discipline in their approach to financial management (45%) than men (39%). Women also admit to being more likely to get stressed easily (low composure); this awareness may partially account for their greater desire for financial discipline.
However, it is men who actually have a greater need for discipline when it comes to investment management as they tend to be over-confident in investing, potentially leading to lower returns. Men are more likely to attempt to strategically time the market instead of simply buying and holding (41%) than women (36%). They are also more likely to trade more than they should (17% of men vs 11% of women).
Women are also slightly more likely to use financial strategies (53%) than men (51%) and perceive them as more effective (62% of women vs 55% of men).
These gender differences may be explained by the tendency for women to be less willing to take financial risks (32% of women vs 49% of men) and to have lower composure levels (42% of women have low composure vs 54% of men).
The use of rules and strategies in financial decision making are seen as extremely effective by wealthy respondents. They provide increased financial satisfaction, and are associated with higher wealth levels for those who report an increased desire for financial discipline. Comparing the group with the highest strategy usage to the lowest strategy usage, there is a 13% boost in financial satisfaction and a 12% rise in wealth.
Greg Davies, Head of Behavioral and Quantitative Finance at Barclays Wealth, said: “Many people will be surprised to see that wealthy individuals have a desire for greater financial discipline, however with increased wealth comes an increased complexity of investment decisions. The key thing that investors need to consider is how these decisions might fit in with their overall investment strategy, and importantly, how they fit in with their individual requirements.”
The report shows that investors use many types of decision making strategies to control their impulses, and use rules more in financial decision making (89%) than they do in everyday life (73%). The most popular rules for financial decision making include using cooling-off periods (92%) and setting deadlines (90%).
While delegating to others (73%) and limiting your options (66%) are less popular strategies, investors with inherited wealth or those at the top of the wealth range are more likely to use these rules than other investors. The report shows that the most popular option is actually to use a combination of strategies: involving others, being more structured and/or removing temptation.
Davies continues: “If we attempt to follow a fully ‘rational’ path without self-control the effects are clear – we will over-trade, and we will buy high and sell low. As a result we will be less effective and less satisfied investors. In order to prevent this we need to take steps to facilitate our efforts to exert self-control.
“This can only happen if we give something up, such as our flexibility to responding to market movements with knee-jerk reactions, or it may mean sacrificing a small amount of the performance of the ‘rational’ portfolio in order to ensure that we have a portfolio with which we’re emotionally comfortable in the short term.”
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(1) This effect was found in a study commissioned by Barclays Wealth UK at the Cass Business School from 1992 to 2009. The total return of UK equity funds was 6.5% but the average investor earned only 5.3%. Compounded over 10 years this difference is quite significant – it is a sacrifice of nearly 20% of one’s return. Many other studies have shown similar results.
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