Barclays’ research found that a need for increased financial discipline is likely to be felt most by those at the wealthiest end of the scale ($15 million or more), where 45% of respondents wish they had more self-control. This is in spite of the report showing that those who desire greater financial discipline are also less likely to be satisfied with their financial situation.
“Emotional trading” can potentially cost investors up to 20% in returns over a decade, and the report shows that investors who frequently use financial self-discipline strategies (such as spending out income, never out of capital, or avoiding frequent examination of a portfolio, thereby resisting the temptation to trade on short term market trends and stray from a long-term investment strategy) are on average 12% wealthier than those who do not.
Barclays found a “trading paradox” caused by emotional trading; investors who buy high and sell low. Worldwide, one third of those polled (32%) believe that to obtain a high return in investing, it is necessary to trade frequently; paradoxically, the very same investors who identify themselves as believing frequent trading is prerequisite for high returns are much more likely to say that they trade too much. In total, almost half (46%) of respondents who believe it is necessary to trade often to do well also believe that emotions force them to do this.
Interestingly, high-net-worth investors in the U.S. seem to have eluded the pitfall of ‘emotional trading’ by taking a more rational approach to investing. U.S. investors are more likely to adopt a buy and hold strategy (23%), recognizing that frequent trading doesn’t necessarily equate to higher returns. Just 15% of U.S. respondents believe that to do well in the financial markets, it is necessary to buy and sell often. Only 8% of wealthy U.S. investors surveyed felt that they trade investments more than they should.
Causes for emotional trading
In order to understand investment behavior and the pitfalls that investors may be prone to, the report considers three personality dimensions: risk tolerance, composure (tendency to heightened emotions) and promotion vs. prevention (focus on making good things happen vs. preventing bad things from happening).
Falling victim to a trading paradox can potentially lead to investors becoming unable to control how often they trade, and even, possibly, becoming addicted to trading. Investors with a combination of high risk tolerance, low composure (marked tendency to heightened emotions and stress), a high prevention focus (very focused on preventing bad things from happening) turned out to be most likely to fall victim to this paradox.
Regionally in the U.S., investors in the South demonstrate the highest incidence of the trading paradox while those in the Northeast demonstrate the lowest. Almost one-quarter (24%) of Southern investors are likely to try to strategically time the market; 17% think trading often is necessary to do well, but believe they trade too much (11%). By contrast, only a fifth of investors (20%) in the Northeast say they try to strategically time the market; only 13% perceive the need to trade often, and only 6% believe that they trade too much.
Globally, respondents in Asia-Pacific have the greatest desire for financial discipline, particularly in Taiwan (#1) and Hong Kong (#2). In contrast, developed markets show the least desire for financial discipline, as illustrated by respondents in Spain (#1), Australia (#2) and the U.S. (#3).
Female investors trade less, earn more
When it comes to disparities among male and female investors, Barclays identified several differences. Women reported a greater desire for discipline in their approach to financial management (45%) than men (39%). Women also admit to being more likely to get stressed easily (low composure); this awareness may partially account for their greater desire for financial discipline.
However, it is men who actually have a greater need for discipline when it comes to investment management, as they tend to be over-confident in investing, potentially leading to lower returns, Barclays wrote in its report. Men are more likely to attempt to strategically time the market instead of simply buying and holding (41%) than women (36%). They are also more likely to trade more than they should (17% of men vs 11% of women).
Women are also slightly more likely to use financial strategies (53%) than men (51%) and perceive them as more effective (62% of women vs 55% of men).
These gender differences may be explained by the tendency for women to be less willing to take financial risks (32% of women versus 49% of men) and to have lower composure levels (42% of women have low composure versus 54% of men).
“Many people will be surprised to see that wealthy individuals have a desire for greater financial discipline, however with increased wealth comes an increased complexity of investment decisions,” said Greg Davies, Head of Behavioral and Quantitative Finance at Barclays Wealth. “The key thing that investors need to consider is how these decisions might fit in with their overall investment strategy, and importantly, how they fit in with their individual requirements.”
The report shows that investors use many types of decision-making strategies to control their impulses, and use rules more in financial decision making (89%) than they do in everyday life (73%). The most popular rules for financial decision making include using cooling-off periods (92%) and setting deadlines (90%).
While delegating to others (73%) and limiting your options (66%) are less popular strategies, investors with inherited wealth or those at the top of the wealth range are more likely to use these rules than other investors. The report shows that the most popular option is actually to use a combination of strategies: involving others, being more structured and/or removing temptation.
The report, Risk and Rules: The Role of Control in Financial Decision Making, is based on a global survey of more than 2,000 high-net worth individuals in 20 countries, and provides an in-depth view of wealthy investors from a behavioral finance perspective.
The complete Barclays report is available here.