Monday, June 13, 2011

Genetics and your investment behavior

We have long observed that some individuals consistently make better decisions with their money than others.  Emotional control is often the most essential characteristic of successful investors.  Market volatility and other stresses can induce extreme emotions that cloud our judgment and prohibit us from thinking rationally.  Many other ingrained personality traits, such as one's  willingness to take risk and general tendency to save or spend, have an important financial impact.  But what causes individuals to decide and behave the way they do? Recent evidence shows that genetic inheritance plays a larger role than we may have thought.

In 2009, researchers from the University of Washington and Claremont McKenna College concluded a joint study titled,"Nature or Nurture: What Determines Investor Behavior?".  Their purpose was to build on previously identified predispositions of investors and quantify how much genetics effects the financial behavior and decisions of individuals. The study compared the behavior of identical twins, non-identical twins and a random sample of investors. The team drew on data from the Swedish Twin Registry and matched the twins directly with their specific portfolio holdings through a quirk in Swedish tax law which had required citizens to report their assets annually.  As a result, the study was able to directly compare the complete portfolios of individuals and categorize their respective investment decisions.  The study concluded that:
"We find that up to 45 percent of the variation in stock market participation, asset allocation, and portfolio risk choices is explained by a genetic component.  Genetic variation is a very important explanation for variation in investment behavior compared to the influence of education, net worth, entrepreneurial activity, and other factors studied in existing work. Furthermore, the family environment is found to have an effect on young individuals' portfolios, but in contrast to the genetic effect, it disappears with age as an individual acquires their own experiences. Frequent contact between individuals leads to a common effect on investment behavior beyond the genetic factor.  Finally, we find that twins who were reared apart still have similar portfolios."

 Source: Michael G. Foster School of Business, University of Washington

One of the lead researchers, University of Washington professor Stephan Siegal, explained “We find that a simple genetic factor explains much more than everything else that people have proposed to explain the difference in investor behavior. Genes matter all the time, even in old age. There is always going to be some part of you that is predetermined at the moment you are born, and we’re learning that the way you invest is at least partly hereditary.”

PBS completed a short inteview with Professor Siegel, which sheds additional light on the study's conclusion:

Interviewer: If we accept the point that your investing behavior is determined by genetics and if you have some bad tendencies when it comes to investing, is there any point to try to control this behavior or try to reform yourself?

SIEGEL: Oh, sure there is, right. We don't say that or we don't find that all of the behavior is genetically determined. It is about 30 percent that is genetically determined and 70 percent are a reflection of peoples' individual experiences and therefore also, of course, choices that people make. So the more than half of the behavior is determined by things that are not controlled by someone's genes.

What we can conclude:
-Recognize and take note of the investment behavior of your parents. You have inherited these characteristics but have the opportunity to learn from the results (Especially if you happen to be a relative of Bernie Madoff!).

-All is not lost if you are a parent worried about the quality of the genes you have passed to your kids.  The authors do not reject the benefits of education/parenting, although recognize its effectiveness declines over time. That being said, institutional investors would be still be wise to ask for DNA samples from prospective managers!