The research shows that our individual investment decisions rarely depend on our education or level of intelligence. In fact, most of the time, our choices depend on our personal experiences.
The reason is simple and very well known to neuroscientists. Human brains are most of the time driven by emotions. There is nothing stronger driving people actions than fear or uncertainty.
That is why the person who never saw the economic crisis would behave totally different from the person who experienced it. An investor who never went through a market crash will have more risk appetite than the person who made heavy losses in the past.
Not only bad experiences shape our personal preferences. Positive memories also influence them.
This might be one of the biggest explanation of why individual investors in America have much higher preferences for equities than in the majority of Europe. Over the last few decades, American equities outperformed European indices by far. The share of equities in an average American saving portfolio is also much higher.
The differences are visible not only between countries but also between generations. It is proven that our experiences at the beginning of our adulthood determine to a large extent, our future investment decisions (even when we do not realize it).
That explains why, in different countries, people invest differently. And why different generations have different investment portfolios.
It is not only the case with individuals without deep financial knowledge. Similar patterns can be found in the professional community. Even traders or portfolio managers have different risk preferences based on their past experiences.
What is the takeaway from that for us?
Firstly, don’t say people’s decisions are irrational or crazy. Everyone act in a way they think is in their best interest. Every decision is based on an individual’s past experiences and current knowledge. Obviously, that means the decisions might be very different. Yet, nobody acts irrationally.
It is also true for people who do not invest or invest overly conservatively. Let’s look at current investment or saving patterns. Interest rates around the world are hitting multi decades lows. Inflation has not really collapsed as in normal recession periods, and lots of economists forecast it might rise in future. As a result, in real terms, the savers will be losing money. Yet, people are hoarding cash in record amounts. Are they acting irrationally? No, they are just afraid of losing money at the time of extreme uncertainty.
Secondly, it underlines the importance of objectivity and open-mindedness in successful investing. It’s hard to achieve for individuals who have limited experience and only partial knowledge (not because they are less skilled or educated but because they spent less time following the markets). Yet, it necessary if you want to be a successful professional. Humility to admit to being wrong and the ability to changing your mind is one of the most important features of a great investor.