Several determinants play a critical role in why some individuals become value-oriented investors and others become growth-oriented investors.
With so much research being done on various aspects of investing, surprisingly little effort has been made to explain the factors that influence individual investors’ decision making. The authors (Nerik Cronq, Stephan Siegel, and Frank Yushow) whose published work was in the 'Journal of Financial Economics' shows that an investor’s investment style (i.e., value versus growth) can be derived from two sources: a genetic or biological predisposition and environmental factors. The authors reference several previous studies and provide their own analysis to contribute a new perspective about why investors gravitate toward value or growth investments.
Differences in individual investor behavior stem from:
Several factors explain an individual investor’s investment preference for either value- or growth-oriented portfolios. The authors estimate that genetic differences account for approximately 26% of the orientation when measured by Price/Earnings ratio and 27% when measured by Morningstar’s Value-Growth Score. This result is consistent with the findings of previous researchers, who have shown that approximately 30% of the cross-sectional variation in financial risk preferences is explained by genetic predispositions. In addition to biological considerations, the analysis demonstrates that particular individual life experiences have a large impact on investment styles.
Significant macroeconomic events (think of Global Financial Crisis, Dotcom Bubble, etc.) that investors experience can also have long-term and persistent effects on that individual’s behavior much later in life.
Conversely and consistent with previous studies, the research find that investors with:
This research contributes to and supports the growing body of evidence regarding behavioral finance, which demonstrates that life experiences, behavioral biases, and genetics have a dramatic impact on investors’ behavior.
This research, coupled with the growing body of literature on cognitive biases can be extremely helpful for individual investors to help understand their tendencies and why they may lean toward various investment strategies or products. By digging a bit deeper and learning more about ourselves, we can make better informed decisions.
-Paul R. Rossi, CFA
Paul R. Rossi, CFA