A fund manager’s childhood can tell a lot about their attitude to risk
Our present investing behaviour is very much shaped by our past
It is tricky for investors to overcome their thinking biases. Photograph: Michael Nagle/Bloomberg
If you were considering investing in an active fund and you had the chance to ask the fund manager some questions, you might ask: How risky is this fund? How has it performed in recent years? What kind of stocks do you focus on?
Here’s another, more personal, question to add to the list: What was your childhood like? Well, maybe not. Still, psychologists have long known that childhood experiences can shape people’s behaviour in later life in all kinds of ways – including, it seems, the financial decision making of fund managers. That’s according to Cambridge finance professor Raghavendra Rau, co-author of a recent study titled Till Death (Or Divorce) Do Us Part: Early-Life Family Disruption and Fund Manager Behaviour, which has found that money managers who experience parental death or divorce at an early age tend to be significantly more cautious in their investment life.
Rau examined the investing activity of more than 500 fund managers between 1980 and 2017 – four decades that encompassed several market cycles, ranging from the 1990s technology bubble and the subsequent crash to the global financial crisis and the recovery that followed.
Managers who experienced trauma at an early age were more risk-averse – they were less likely to invest in risky lottery-like stocks; more likely to stay closer to benchmark indices; more likely to sell stocks when market volatility increases; more likely to sell the shares of companies that take on additional risk (especially high-risk takeovers involving foreign or non-public companies); and had lower fund turnover.
The death of a parent, Rau found, was more likely to have a greater impact on a fund manager’s risk appetite than a divorce.
The tendency to shy away from risk was especially pronounced among managers who experienced trauma during their formative years (ages 5 to 15), as opposed to during non-formative years (0–4 and 15–19). Additionally, financial risk aversion was more pronounced when the bereaved parent either had no new partner or had little social support. Essentially, the greater the psychological shock, the greater the subsequent risk aversion. Rau’s findings echo the medical literature. Various studies have found that parental loss during childhood is linked to higher levels of anxiety, long-term increases in blood pressure and the stress hormone cortisol, and biological changes in the brain. The various changes, says Rau, “may plausibly lead to changes in the individual’s preferences, including the preference to take risk”. This is not the first study by Rau to show that early experiences can shape financial decision making. A 2015 paper, ‘What Doesn’t Kill You Will Only Make You More Risk-Loving: Early-Life Disasters and CEO Behavior’, won the Ig Nobel Prize, a light-hearted award that aims to honour achievements “that first make people laugh, and then make them think”.
The study found that chief executives who grew up in areas that experienced fatal natural disasters, but without experiencing any negative personal consequences, went on to take more risk in their corporate careers and to lead firms that behaved more aggressively. Emerging unscathed from such events, Rau suggested, “desensitises CEOs to the negative consequences of risk”.
In contrast, CEOs who experienced natural disasters involving extreme levels of fatalities during their early life went on to become more cautious leaders.
Separate research confirms that one’s appetite for risk is very much shaped by one’s life experiences. A 2017 paper, Formative Experiences and Portfolio Choice: Evidence from the Finnish Great Depression, found that experiences in the job market can have a “long-lasting impact” on investment attitudes.
Workers who were negatively affected by the economic depression that gripped Finland in the early 1990s, when real GDP fell by 10 per cent and unemployment soared from 3 to 16 per cent, were less likely in later life to invest in stocks and other risky assets, the researchers found. These negative effects even “travel through social networks”; people whose neighbours and family members experienced difficult economic circumstances were also more likely to avoid risky assets more than a decade later. Another paper published in the Journal of Financial Economics earlier this year, Once Bitten, Twice Shy: The Power of Personal Experiences in Risk Taking, examined the subsequent investing behaviour of ordinary investors in Denmark who lost money on bank stocks during the 2007-09 global economic crisis. An appropriate response to those losses, the researchers noted, would have been for investors to diversify their portfolios. Instead, investors learned the wrong lesson, choosing to sell any risky assets they inherited and to opt for the false comfort of cash.
“Personal experiences are so powerful that they make individuals actively shy away from risk,” the researchers noted. Investors’ reaction is one of “once bitten, twice shy”. In his essay The Psychology of Money, Morgan Housel of the Collaborative Fund notes that your personal experiences “make up maybe 0.00000001 per cent of what’s happened in the world but maybe 80 per cent of how you think the world works”.
If you were born in 1970, he notes, you would have witnessed the stock market skyrocket higher during your teens and 20s – “your young impressionable years when you were learning baseline knowledge about how investing and the economy work”. Someone born in 1950, in contrast, saw the same market go nowhere in their teens and 20s. People experience “a fraction of what’s out there” but make the mistake of using those experiences “to explain everything they expect to happen”.
Housel is right, although he may actually be underestimating how tricky it is for investors to overcome their thinking biases. Raghavendra Rau’s research on early childhood traumas matters, says money manager and Bloomberg columnist Barry Ritholtz, because we are “often unaware of what drives our decision-making”. Learning about behavioural finance and our inherent biases helps investors to avoid “some of the more obvious errors”, says Ritholtz, but it “gets much trickier when any investor might need to take into account personal childhood traumas, and other subjective events”. That’s echoed by Prof Rau. Fund managers typically have extensive financial training and experience before they take over funds, he notes, and yet it seems their attitudes towards financial risk continue to be influenced by personal events that happened decades earlier.
Ordinary investors, of course, don’t have the same training or financial awareness, making it all the more likely that our present investing behaviour is very much shaped by our past.