What type of investor are you?

AN early start in her investing journey has done wonders for Michelle. At 40, the former banker has stopped working and spends her time “mostly travelling”.

Her secret? “I started saving and investing in my 20s, so it’s not overnight,” she said.

Michelle is a member of the small but growing “Fire” movement. The term is an acronym for “financial independence, retire early”, and is a lifestyle movement rather than an investing strategy: Maximise your savings and invest aggressively, with the objective of generating sufficient passive income to become financially independent.

Proponents of the Fire movement typically advocate setting aside 50 to 75 per cent of one’s income. This is invested to build a passive income source. Paid work then becomes optional, allowing for retirement at an earlier age.

A Fire lifestyle isn’t for everyone, and experts say success depends on a number of factors. These would include inherited wealth, earning power, lifestyle expectations and an investor’s personality.

“Fire investors will need to invest aggressively to maintain their desired lifestyle at retirement, which makes them susceptible to market volatility – especially when market cycles turn, and they thus run the risk of prematurely depleting their nest egg,” said Aaron Chwee, OCBC’s head of wealth advisory.

In times of extreme uncertainty – as we are in now – investors may face tough investment choices. Understanding one’s personal approach to investing can help.

Behavioural bias

Investor behaviour is an established field of academic study, with behavioural biases having significant impact on investment outcomes.

“People in general have a tendency for certain biases,” said Massimo Massa, the Rothschild chaired professor of banking and professor of finance at Insead.

Studies have shown individuals of different gender, religion, race and nationality, to name a few factors, display different willingness to take risks, Massa said.

Some of these differences are easy enough to understand.

Older investors may prefer to preserve the value of their assets as retirement approaches, rather than take on excessive risk in their portfolios.

On the other hand, the younger or more financially savvy investors who understand market trends and companies’ financials may be more open to taking on greater risk.

Other biases, however, are less obvious.

“Family and even childhood experiences can subconsciously play a role in shaping investors’ behaviours,” said OCBC’s Chwee. “An investor whose family has tasted bankruptcy may be risk-averse, while an investor whose family was not well off may be spurred to take on higher levels of risk to accumulate more wealth to improve their family’s economic status.”

Cultural backgrounds often play a part in investor behaviour and priorities too.

Standard Chartered published a study last year on investor personalities, picking 9 distinguishing traits: confidence, impulsivity, speculation, composure, financial comfort, desire for guidance, desire for legacy, internal locus of control and risk tolerance.

These were then distilled into 3 main investor archetypes: the comfortable investor, the conservative investor and the enthusiastic investor.

The study found that Singapore investors’ top 3 personality traits were a desire for legacy, confidence and financial comfort.

Singapore investors were also more likely to be “comfortable”, scoring high on composure, confidence, internal locus of control and financial comfort, but low on impulsivity and speculation.

One of the biggest behavioural biases detrimental to investors, Prof Massa said, is the inability to come to terms with losses.

“Many people cannot differentiate between risks and rewards,” he said. “If you hate losses more than you love gains, for example, your portfolio could be up overall, but you would still be unhappy.”

In some cases, such bias could lead to investors hanging on to their losses – or even doubling down on loss-making investments – while selling winners.

“There are also studies that show that people with access to internet brokerage platforms will trade more – and lose more money,” Massa said.

Another top behavioural trap is paralysis caused by fear of doing the wrong thing.

In a blog post in January, Christian Gattiker, head of research at private bank Julius Baer, noted that this phenomenon tends to occur when there has been a market crisis and investors have been spooked.

“Every human being is driven by emotions – more than we would like to admit. Emotions are the drivers of our behaviour, and these behavioural patterns shape our way of investing, for better or worse,” Gattiker said.

Other traps include attaching more credibility to stories that support our views and dismissing those that do not, as well as “herding” – where investors run in the same direction in the belief that the person in front of the herd knows more than they do.

“People often have to find out the hard way that intuition and emotions are a trap,” he added. “No one is immune to these behavioural traits; they affect not just private investors but professional fund managers, too.”

Different strokes for different folks

Given such biases, as well as differing goals, investment advisers emphasise there is no “right way” to invest.

“It can only be ‘the right way’ of investing at the right time, for the right investment objective,” said Clare Tay, head of wealth client engagement at Standard Chartered (StanChart), noting that most of the bank’s clients may have several investment objectives in mind.

For example, an affluent individual may be looking at retirement planning for himself while considering legacy planning for his children. In such cases, the individual may choose to set up multiple portfolios for multiple goals.

Risk tolerance is another important consideration. “An investor must understand not just their tolerance for risk, but also their ability to stick to their personal investment strategy during times of uncertainty,” said Tay.

Understanding their personal risk tolerance also helps investors figure out whether to “tweak their investment strategy by cutting losses and waiting for a good point of re-entry”, or to “stay the course and continue to average down on their overall investment purchase price during market corrections”.

At OCBC, Chwee said, a financial needs analysis is performed for each investor, so the bank can establish a better understanding of the customer’s needs and recommend the right financial products and financial plan.

“Understanding the needs of each customer – their goals and motivations – can make a difference in guiding them towards cultivating the appropriate investment style that works for them,” Chwee said. “There is no one-size-fits all approach when it comes to investing, and financial plans have to be tailored towards each individual.”

The needs analysis also helps OCBC get an idea of how much an investor might be able to commit. “It is important for us to understand our customers’ financial situations because this can have an impact on their investment results. For example, the availability of emergency funds, their monthly outflows and cashflow can potentially cap the risk-taking ability of an investor.”

In line with industry guidelines, banks and financial institutions typically categorise clients according to 5 or 6 risk profiles, ranging from “very conservative” to “very aggressive”.

Prof Massa noted, however, that the surveys the banks and financial institutions typically use as a gauge of investors’ risk appetites are more regulatory than behavioural.

But the study of behavioural bias can also be turned into an investing advantage, he said.

To illustrate: Investors facing losses have a tendency to hold on to stocks even when bad news hits, such as when a company announces an earnings miss.

“If investors are rational, the stock price drop will take place in the first month. But because of behavioural biases, the stock price is artificially kept higher by people not willing to face their losses or not adjusting in time,” Prof Massa said.

This creates a window of opportunity for investors to capitalise on the delayed price action.

“The behavioural patterns are implicit and therefore often overlooked or unknown. This may explain why, although the majority cannot help but be influenced by their emotions when making investment decisions, most, if asked, would say that they are not,” said Julius Baer’s Gattiker.

Yet, he is of the view that there is still value in human judgement instead of relying purely on rule-based investment like machines.

“If rules alone were enough, machines would consistently make better investment decisions than human beings. However, that is not the case,” Gattiker said. “The key to breaking out of this pattern is to use both judgement and rules together in a complementary way, not just rely on one.”

“It’s necessary to use judgement to understand the dynamics of market movements but also to make a cool, rule-based assessment of the numbers,” he added.

Fire in the belly

An understanding of investment biases is equally important for both banks and individual investors, Prof Massa said. As he puts it: “Is it more important for the patient to know he has a disease, or for the doctor to know how to manage it?”

Those who are seeking to attain early retirement, meanwhile, should be clear about the necessary sacrifices and the possible rewards.

The Fire movement is not a “silver bullet”, said Tay of StanChart. “It’s not just an arithmetic solution whereby the individual could estimate and ensure the amount they have saved is enough to last them till the end of their life expectancy – factoring inflation – or that the passive income can also consistently contribute towards their regular expenditure in the long term.

“An individual who wants to pursue the Fire movement might have to choose a less lavish lifestyle to avoid the trappings of lifestyle inflation. One should also take into account whether their post-retirement hobbies could generate income, or are of a more financially taxing nature and may drain their savings.”

For many without substantial means, Fire may also be a “pipe dream”, said associate professor Tan Ern Ser, a sociologist at the National University of Singapore (NUS).

“I reckon (Fire) is a rational ambition, given that we now live in a Vuca (volatility, uncertainty, complexity and ambiguity) world characterised by risks and insecurity of all sorts,” Tan said.

Nevertheless, only “a small minority” will be able to successfully achieve Fire status and live the “good life” with their wealth – inherited and/or earned – plus passive income.

“A larger minority, who have learned to live with less, may attain Fire status if they figure that they have sufficient reserves to achieve a ‘good enough’ life, as opposed to the ‘good life’,” Tan said, noting that this would involve calculated risk.

For Michelle, the early retiree, her current leisurely lifestyle has been possible thanks to some astute investments made mostly by someone else. A fairly passive investor, Michelle said she actually leaves most of the investing decisions to her spouse.

What does she own? “Not crypto,” she said.