How do we decide what investment strategy to follow? For many of us, there is an element of chance involved. Perhaps a particular investment strategy is popular during our formative investing years. Or maybe we were inspired by an early mentor, or read a famous book describing winning ways. Once we start pursuing an investment strategy, however, we rarely stop to think about whether it is a good fit for our unique circumstances. Of course, if we invest for long enough, we may gravitate towards a strategy that suits us, but it often happens through trial and error rather than conscious thought.
When it comes to adapting their strategy, investors are often their own worst enemy. The average investor has poor market timing instincts. Investors tend to jump into something after an extended period of positive returns, switching out when they just can't take the pain of underperforming investments anymore. The problem is that over periods of a few years, investments tend to suffer from mean reversion. As a result, the top quartile funds over three years are more likely to be in the bottom quartile than the top quartile in future years. Investors make the switch just as the outperforming funds start to underperform. The same happens with individual stocks. In a 1999 study of around 50,000 individual investor trades, Terence Odean found that the stocks that investors sold outperformed the ones they bought.
Every successful investment strategy is hard, either analytically or psychologically. It has to be; if there were an easy way to beat the market, we would all do it, and it would stop working. The best strategy is, therefore, one that you can follow consistently, through periods of underperformance, without switching at the worst possible moment. We will find it much easier to stick with a strategy if we find one that matches our unique personality.
While there are many different models of personality, the most widely accepted is called the 'Big Five' consisting of the following, mainly independent, traits:
Agreeableness represents how inclined to share and co-operate with others we are. It measures how willing we are to "go with the flow" and accept the opinion of others.
Conscientiousness is how thoughtful and detail-orientated we are and is often related to strong impulse control.
Extraversion can be described as the extent to which the company of others energises someone. Extraversion is often mischaracterised…
