Understanding Investor Type

Investor type helps advisors better understand how clients behave when the market fluctuates. Common investor types are: passive investor, trend follower, and contrarian. This questionnaire is adapted from the research by Dr. Andrew Lo from MIT.

Also known as buy-and-hold investors, passive investors tend to stay put during market ups and downs, taking a long-term view of the market. A common investment strategy is to buy index funds and hold them.

Research suggests that investment returns are primarily driven by asset allocation, not stock picking nor market timing, which validates this approach.

Trend followers tend to follow the market trend, buying when the market is going up and selling when it’s going down, driven by emotions such as fear and greed.

When prices are rising, they are motivated by the fear of missing out (FOMO) on potential gains. Conversely, they sell when prices are falling to avoid further losses, driven by panic. 

Buying high and selling low is counterproductive to investment success. Professional investment managers may do this to capitalize on the momentum, relying on technical analysis to identify market trends to determine entry and exit points. However, it is very difficult to get it right, even for professionals.

In both cases, this behavior can amplify market trends, leading to overbought or oversold conditions, contributing to the boom and bust market cycles.

Contrarians, on the other hand, go against prevailing market trends, buying when others are selling and selling when others are buying. They believe that popular opinion often leads to overreactions, creating opportunities to profit from market corrections. Contrarians seek undervalued assets that are out of favor with the majority and avoid overhyped investments that may be overpriced. 

This approach requires a strong conviction and patience, as it often involves taking positions that are unpopular and may take time to pay off. Successful contrarian investors rely on thorough research and a deep understanding of market fundamentals to identify mispriced opportunities. 

Safety seekers are investors who prioritize the preservation of capital over potential high returns. They prefer low-risk investments that offer stability and predictability, such as government bonds, high-quality corporate bonds, and blue-chip stocks with stable dividends.

Safety seekers often avoid volatile assets like stocks of high-growth companies or speculative investments. Their primary goal is to protect their investment principal and achieve steady, modest growth. This conservative approach is typically favored by those nearing retirement, risk-averse individuals, or those with short-term financial goals. While safety seekers may miss out on higher returns, they benefit from reduced risk and greater financial security.

Risk seekers are investors who actively pursue high returns by investing in assets with higher levels of risk. They are willing to tolerate significant volatility and potential losses in exchange for the possibility of substantial gains.

Risk seekers often invest in high-growth stocks, speculative investments, emerging markets, and other volatile assets. They thrive on market fluctuations and are often driven by the potential for quick and significant profit. This aggressive investment approach can lead to high rewards, but it also carries the risk of substantial losses. Successful risk seekers rely on thorough research, market insight, and a high tolerance for uncertainty to navigate their investment choices.

Adaptive investors are able to change their strategies based on market shifts and new information. They don’t stick to one fixed plan but adjust their approach as needed to navigate changing conditions.

Non-typical investors display a mix of traits. For example, it may display the trait of a passive investor at times and contrarian other times, hence not a stereotypical passive investor or trend follower. 

A client’s investor type has a major impact on the advisor-client relationship; hence it is part of the “Risk Tolerance Plus” flow, the first priority to give to clients.

You can use it to screen prospective clients. Trend followers, for example, require more handholding and may not be a good fit. It also helps you customize conversations with existing clients.

While investor type and behavioral biases are each independently assessed, there are some correlations. For example, trend followers tend to believe that they can time the market, which shows overconfidence in their capabilities. They also tend to have herding, another common behavioral bias, although they may not recognize it themselves.

Copyright © 2022. Andes Wealth Technologies. All rights reserved.