Imagine you’re a talent scout for an unusual investment firm. Unlike typical funds, yours only hires people with no prior investing experience; your job is to identify the superstar fund managers who don’t even know their abilities.
Who do you choose?
Countless books and academic studies have found who not to pick. Those prone to loss aversion tend to overtrade and underperform the market. It’s one of the surest signs of a candidate to avoid. And individuals who refuse to learn are usually left behind, whether because of anchoring bias, status-quo bias, or the plain unwillingness to change a strategy that doesn’t work. One landmark bet between two Wall Street titans found that traders can be taught to outperform if they select the right people to start.
And don’t believe for a moment that the perfect investor is devoid of all emotion. Properly functioning humans are all hardwired to have some feelings, which are essential in helping us form judgments. Studies have shown that people who suffer from alexithymia — the clinical inability to feel or describe emotions — are “less able to generalize the value of previously learned actions that lead to a negative outcome.”
In other words, that awful feeling we get from making mistakes conditions us to avoid repeating the error.
But few people talk about what behavioral traits actually work. What did these Wall Street titans look for? And as your own investment manager, what characteristics should you emphasize when picking stocks?
Fortunately, one essential trait defines high-performing investors.
How Conscientious Are You?
Of all personality traits, conscientiousness has been shown to have an outsized effect on financial well-being. Here, we’ll define it by its proper psychological term:
The individual differences in the propensity to follow socially prescribed norms for impulse control, to be goal-directed, planful, able to delay gratification, and to follow norms and rules.
And if there’s a superpower investment ability, conscientiousness is it.
Not only are conscientious individuals more likely to save money and avoid excess spending. They’re also more likely to outperform the market. One 2016 study of 255 Vietnamese investors found that “conscientiousness and openness experience” was the single best predictor of outperformance, followed by “investing with a positive outlook” in a distant second place. A more recent 2023 study by American authors found conscientious people are less likely to panic and sell out during market drawdowns. These are the investors most likely to remain invested in the long run, a factor long proven to help increase returns.
It’s an observation most Wall Street analysts will also know well. Consider the alternative. Though some neurotic individuals become successful in finance, these people are often better at making money from others rather than for them. No talented portfolio manager wants to work for a Wolf of Wall Street, and studies show that neurotic individuals are less likely to invest in stocks in the first place. Meanwhile, the top-performing funds generally exhibit lower turnover, a key element consistent with conscientious investing.
Admittedly, no study has yet examined precisely how much these investors outperform. Conscientiousness creates confounding factors, such as higher savings rates, more college graduations and a willingness to invest in equities. These factors increase financial accumulation but have little direct effect on stock-picking performance. Still, the Vietnamese paper suggests that a stunning 87% of investor outperformance can be traced back to how conscientious they are. It’s enough to indicate that a little bit of this trait can go a long way in returns.
Why Does Conscientious Matter in Investing?
Several factors help explain the expected outcome.
- Impulse Control. Conscientious investors are better at absorbing market information than their peers. Of the Big 5 personality traits, they are less likely to have knee-jerk reactions to market news than those who score high on neuroticism or extraversion.
- Patience. Conscientious investors are better equipped for waiting on stocks and other assets to reach fair value before selling. They are less tempted to get out at the first sign of gains or losses.
- Goal-Directed. Over 90% of investment returns depend on asset allocation. Conscientious investors who create and follow goal-directed plans are more likely to build long-term wealth.
- Delaying Gratification. Long investment time horizons help reduce tax burdens. Avoiding liquidating a 401(k) early or borrowing against them shields returns from early withdrawal penalties and interest expense.
Fortunately, we know that people become more conscientious the older they get.
How to Invest Better
Clinical psychologists have written tomes on becoming more conscientious without waiting for age to take over. These strategies include everything from cognitive therapy to saying, “just do it,” which can often sound downright depressing. Most clinical research shows that it’s hard to change someone’s character.
But here’s a trick:
To invest well, it’s often enough to mimic conscientiousness.
And here are three steps that can help.
1. Have a Plan. And Use Help to Follow Through. The greatest enemy of personal wealth isn’t overtrading. It’s neglect. As a financial advisor, I’ve seen individuals across the wealth spectrum avoid checking their bank accounts… And consistently checking their investment accounts can feel even harder. That means investors who want to become conscientious can begin by creating a financial plan, drawing up an asset allocation, and then using automated tools to help with implementation. Opening a sweep account can help push excess savings into investments automatically, while certain ETFs can automatically rebalance allocation over an investor’s lifetime.
2. Create Consistent Investment Rules. Investors can also mimic conscientiousness by creating and following consistent investment rules. My quantitative research has shown that many investment strategies can beat the market; growth, value and momentum trading can all work if done correctly. The role of a conscientious investor is to pick a working strategy and stick with it.
3. Find the Right Friends. Finally, studies show that choosing the right associates can help “sculpt” an individual’s temperament. It’s known as the “Michelangelo phenomenon” and is an effective way to shape personality. And if you can’t find the right people to associate with? Then following the right financial writers and investors might suffice. You might not get to meet Warren Buffett or Peter Lynch in person, but you can always buy one of their books or read their annual letters to get insights straight from their mouth.
Conclusion: Conscientiousness at Work
Of course, there will always be exceptions to the rule. The Vietnamese study only found correlations between investment performance and conscientiousness, which is not the same as causation. Plenty of conscientious people can mistime the market or make lousy investment choices, while non-conscientious investors can succeed.
But on average, investing with good habits tends to generate superior results.
This fact is true even at the institutional level. Research finds that Morningstar fund ratings, which grade mutual funds on management and oversight criteria, are strong predictors of fund returns. In other words, better-managed funds do better than worse-managed ones. And you only need to scan the front pages of social media to find plenty of bad investing habits and significant losses along the way. Meme stocks are proven loss-makers for long-run investors.
Conscientiousness might be challenging to achieve in everyday life. But if you can mimic the ability to invest, then returns will surely follow.
On the date of publication, Tom Yeung did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.