Our investment performance is due in part to our genes, according to new research. Daniel Barth, Nicholas Papageorge and Kevin Thom, three US researchers, have found that genetic endowments related to educational attainment “strongly predict” people’s wealth at retirement even controlling for actual levels of education as well as incomes and inheritances. This suggests that genes affect how well we save and invest.
But what’s the mechanism? Intelligence is only part of the story. Mark Grinblatt at the University of California in Los Angeles has found that more intelligent investors do only slightly better than less smart ones. One reason for this is that investors who think they are clever become over-confident and so waste money by trading too much or by thinking they are smart enough to spot good but expensive fund managers.
This corroborates Warren Buffett’s claim that “investing is not a game where the guy with the 160 IQ beats the guy with a 130 IQ”. Instead, he believes, it is character traits such as self-discipline that matter. This, of course, is consistent with Professor Barth’s finding; it might be that self-discipline has a genetic element and leads to higher educational attainment as well as higher savings and good investment performance.
There are other routes whereby genes affect how rich we get, even controlling for income. In a series of studies of twins in Sweden, Henrik Cronqvist and Stephan Siegel have found that around one-third of the variation in how much people save and how much they invest in shares can be explained (statistically speaking) by genetic variations. What’s more, they show that almost half of the variation in investors’ vulnerability to well-known investment mistakes such as selling winners too quickly or trading too much are associated with genetic variations.
We also have evidence that particular character traits are associated with how we invest. Economists at the University of Western Australia have found that people who are more extravert and less masculine make better investors than others, in part because they are less likely to churn their portfolios a lot.
In a similar vein, new research by Matthew Jordan and David Rand at Yale University has found that appetite for risk is positively correlated with inquisitiveness and leadership. They also found that greater self-control is associated with having longer time horizons. This might help explain the correlation between education and investment performance; self-control helps people both to study harder and to save more.
None of this, however, means our investment performance is immutable. Professors Cronqvist and Siegel found that genes explain much less of investors’ proneness to mistakes among those who had worked in finance. This is consistent with the possibility that people can learn to avoid mistakes. In fact, it might well be that one reason why the same genes predict both educational attainment and retirement wealth is that some people are better able to learn how to invest well than others.
Nor does any of this mean that it is always 'good' character traits that promote investment success, as some new research by Heiner Schumacher at the Catholic University of Leuven and colleagues have shown. They ran experiments in which subjects were offered a choice between two uncorrelated bets each of which had a 50:50 chance of a high or low return: subjects were told in advance about the pay-off structure. After each return was observed the subjects were given the option of changing their allocation between the two bets.
The rational thing to do here is nothing: because returns are random, seeing past returns tells us nothing about future ones. Very few subjects, however, did nothing. And some were especially likely to chop and change. These were those who believed that success is due more to individuals’ effort than to luck – those with what psychologists call an internal locus of control. Such people, says Professor Schumacher, find it difficult to do nothing and instead try to look for patterns and take control even when there are no patterns to be found and no control to take. This can be an expensive mistake if people pay to be active investors, for example by incurring extra dealing fees.
But here’s the thing. An internal locus of control is often a good thing. If you believe success is down to your own efforts you’ll be motivated to work harder and you might therefore be more likely to actually succeed. It's for this reason that Deborah Cobb-Clark at the University of Melbourne has found “compelling evidence that having an internal locus of control is associated with labour market success”. As Harry Kane has said, “to achieve anything in life, you have to believe”.
What works in the labour market, however, might not work so well in financial markets where returns are noisy and luck matters. Sometimes, what makes us succeed at work might make us bad investors. As Aristotle said, what is a virtue in some contexts can be a vice in others.
The point here is that our investment performance is to some extent shaped by character traits via mechanisms of which we might not be wholly aware. As investors it pays therefore to know ourselves and our limits. As Mr Buffett’s colleague Charlie Munger has said, we must know the edge of our own competence.
