“Mutual fund investments are subject to market risks, read all scheme-related documents carefully.” This all-too familiar warning was made mandatory in all audio-visual advertisements for mutual funds in 2013 by SEBI, the securities regulator in India. The boom in the financial markets around that time ensured that we were exposed to advertisements for mutual funds quite frequently — therefore, this five-second warning, read out rapidly, was drilled into our collective consciousness. Whether or not this has made us any wiser when it comes to choosing investments is still up for debate, but if nothing else, we’ve all come to recognise the term ‘market risk’.
Admittedly, ‘market risk’ may prompt a sense of dread or uncertainty for a layperson, but there are established standards and guidelines within the financial realm for what it denotes and how to calculate it. For one, there are ‘systematic risks’ and ‘unsystematic risks’, and both form an integral part of market risks. These risks are essentially factors that affect the overall performance of investments in the financial markets, and ultimately result in market losses. Recessions, political turmoil, pandemics, and changes in interest rates would be factors that are classified as systematic risks; whereas unsystematic risks involve relatively more micro factors that are specific to a company or industry.
Many of us have witnessed close friends or family members concentrating their portfolios on the most-hyped stocks, being overconfident and investing their savings in volatile financial instruments with expectations of high returns, or frantically selling their portfolios in panic when asset prices begin to fall. These decisions are made in response to market dynamics, but they might also be driven by factors that have more to do with our inherent behavioural tendencies.
Undoubtedly, an investor needs to be well-informed of market risks before they become more savvy in their dealings with the market. But apart from market risks alone, perhaps it’s also key that we as investors consider the possibility of more personal reasons for why we keep falling prey to poor decisions. Could our attitude to market risk be linked to our personality traits? Moreover, should we be taking into account our personality traits or characteristics before calculating the risks we are willing to take and choosing our investments?
The five-factor model of personality (also known as the OCEAN model) categorises our personality into five primary traits: extraversion, agreeableness, openness, conscientiousness, and neuroticism. A study in the Journal of Risk Research on the relationship between personality and propensity for risk observed that overall risk-taking would be predicted by high scores in extraversion and openness, and by low scores in neuroticism, agreeableness, and conscientiousness. Evolutionary psychology tells us that we are hardwired for certain dispositions and that some people are more dominant or more optimistic than others. And if you were to work to alter your personality — not all camps of research agree that you can — it may depend on certain incentives. Researchers at the Harvard Business Review write, “What we found is that people may positively change their personalities by increasing their engagement in activities that fit three criteria: They feel important, enjoyable, and they accord with their values.” In short, the reason for change ought to align with your core values and mustn’t seem like a struggle.
This hypothesis is equally true when it comes to investment psychology. You’re likely to be more at peace with your investment choices when you consider your personality traits before making the investment. Comfort will also come from being able to assess whether the risks associated with the investment will be a constant struggle to reconcile with or if you’re able to adjust to the ups and downs of the market without making anxious decisions and falling prey to herd instincts.
As a retail investor, market risks are beyond your control. But what is very much in your control is understanding your personality traits and your appetite for risk, as linked to your personality. In our opinion, “investments are subject to your personality traits” is the sound warning that your financial advisor should be alerting you to.