What Type of Investor Are You?

Young people are taking too much risk with money they can't afford to lose, the regulator warns, with social media and apps fuelling the rise of the thrill-seeking investor

26/03/2021 17:09:00
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Poker chips

Are you a thinker, a gambler or a “have-a-go” investor? The answer may reveal your age, your level of investing experience – and how likely you are to take on risks that could be seriously damaging to your wealth.

New research commissioned by the FCA into DIY investing suggests the boom in trading apps, lockdown boredom and social media buzz, are leading some novice investors to take a “thrill-seeking” approach that could have harmful consequences for their long-term financial plans.

Spectacular daily gains for the likes of GameStop may also give the impression that the stock market is a place where “easy money” can be made, an idea that’s most tempting to young investors.

Research group BritainThinks has published a report on the self-directed investor, someone who makes investment decisions on their own behalf, without using a financial adviser. BritainThinks divides the DIY investor approach into three main groups: “Having a go”, “Thinking it through” and “The Gambler”.

The first category covers inexperienced investors who “adopt shortcuts to decision making which can include going with ‘hyped’ options they have heard a lot about”. The “think it through” cohort are more experienced, generally older and sometimes have a professional background in finance. And “The Gambler” treats investing as betting, looking to short-term gains via high-risk products like Contracts for Difference (CFDs). Given the level of technical knowledge required to be a “Gambler”, this type is often a tech-literate and sophisticated investor with a higher disposable income than the other groups. But they are similar to the “Have a go” group in that they enjoy the thrill of risking money for the chance of a better return.

TikTok Investing

Let’s look at the “have a go heroes” in closer detail and why the FCA is most concerned about this group of investors buying unsuitable investments.

These investors are typically younger, more likely to be women or from BAME backgrounds and, crucially, more likely to use shortcuts to make decisions – investing in hyped companies or assets (Bitcoin) or well-known firms like (Amazon/Tesla) which are perceived to be low risk because of their size and prominence.

Social media has a much bigger impact on this group than others, and those in the survey mention making decisions based on YouTube and TikTok videos. “I started investing this year in Bitcoin. I was initially sceptical but I watched a video saying it was the future,” said one respondent.

“Have a go” investors tend to heed the advice of a small number of people they trust, whether online influencers or friends and family. Researchers say this cocktail of factors makes this group highly persuadable and vulnerable to high-pressure sales tactics and even scams.

The regulator is also worried that people are investing money they can’t afford to lose and downplaying or not fully understanding the risks. One key finding from the research likely to trouble policymakers is that a large chunk of respondents (nearly 40%) did not mention saving for retirement or making their money work harder as reasons for investing.

Doing Nothing

The FCA calls this functional investing, the often laborious process of getting your money to work for you over the long-term. Writing about the GameStop saga, Morningstar’s head of manager research, Jeffrey Ptak, says that true investing should be “boring” if you’re doing it right: “You put the money in, wonder where it goes, leave it alone, watch it fitfully grow, and repeat the process.”

Our passive funds expert Ben Johnson thinks the GameStop drama, Bitcoin mania etc all add up to one conclusion: the stock market is in manic mode and many investors are scared of missing the fun (including our have a go newbies). What should a sceptical investor do in this phase? “Doing a whole lot of nothing might be the ultimate contrarian approach in a market that’s gone manic,” he says.

Morningstar Investment Management’s Dan Kemp, meanwhile, says investors tend to make similar behavioural mistakes – and this applies particularly to new investors. One of these is the “endowment effect” which means you assign a greater value to an asset if you own it (ie Bitcoin); another is “recency bias”, which means you assume an investment’s latest performance will continue. This is similar to the “hot hand fallacy”, where investors assume that an asset or stock on a winning streak is more likely to be successful in the future.

Don't Follow the Crowd

It’s never been easier to be a DIY investor, with a range of platforms offering competitively priced access to a range of financial products – and this has been described as a “democratisation” of investing, one fuelled by advances in technology. This should increase transparency, widen the investor base and hopefully drive down trading costs. Making mistakes early in your investing journey should in theory be beneficial, as long as they don't wipe you out. The challenge for financial advisers, regulators and platform providers, is how to engage with this new tech-savvy group of investors who are used to doing everything themselves.

It’s encouraging that people from more diverse backgrounds are taking an interest in the stock market – but as the regulator points out, this group are the least financially resilient of all DIY investors, especially after the pandemic.

How Can New Investors Protect Themselves?

Susanna Streeter, senior investment analyst at Hargreaves Lansdown, says trading apps have opened up the world of investing but need to be used thoughtfully: "If you are trading on the go, you need to ensure you give each trade as much consideration as you would if you were sitting in a quiet place at home."

The FCA has some questions investors can ask themselves before taking the plunge:

  • do I understand what I'm buying?
  • am I comfortable with the level of risk? 
  • am I protected if things go wrong? (for example, with the FSCS)

 

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