Grit buffers investors from loss aversion.
Author: Kirsty O’Hara
Written: 28 09 2022
5 min read
Most people don’t expect to hear that rich-listers may occasionally struggle with mental health, however they are just as much at risk as the rest of us. When life throws curveballs, we all must find a way to move forward.
The one thing successful people (even rich-listers) often have going for them, is the intrinsic power of knowing they have overcome hurdles before. Generally they have set a goal, made a plan, navigated accordingly, dodged unforeseen spanners, and seen the goal through to completion. Most likely, it hasn’t always been easy. Sacrifices’ may have been made; two minute noodles may have been eaten; and invitations sometimes declined in favour of some good old DIY or hard slog.
If you’re the child of gritty goal-oriented parents, you may have benefited from watching them set and achieve goals - and have an observed understanding that grittiness can be an asset in life.
If you’re a gritty parent, you probably know how challenging (yet valuable) goal setting and ‘character building moments’ are towards building a foundation of grit and perseverance, which are traits that money can’t buy.
What is grit?
Penn-Wharton professor, Angela Duckworth's summarises: "Grit is about having the same top-level goal for a very long time and sticking to it" with a mix of passion and perseverance.
Determination is not “grit”. Perseverance alone is not “grit”. Duckworth elaborates that ‘grit is about having what some researchers call an “ultimate concern”– a goal you care about so much that it organizes and gives meaning to almost everything you do. And grit is holding steadfast to that goal. Even when you fall down. Even when you screw up. Even when progress toward that goal is halting or slow’. With a focus on effort, over talent or luck, there is no chapter about getting rich quick in Duckworth’s books.
What’s so great about grit?
If we look to the literature, studies confirm that people with gritty personalities are more likely to make a plan and stick to it. Duckworth, writes in her acclaimed book on grit that: “Hard work and persistence aren't just virtues, they're cold hard facts of success”.
So, what’s this got to do with investing … ?
Grit and investing.
In a 2021 study about “Grit, Loss Aversion, and Investor Behaviour” (conducted by William Bazley, Sima Jannati, and George M. Korniotis) they questioned if having a gritty disposition would have implications for financial decision-making?
The goal of the experiments, was to establish a link between grit and decision-making.
Participants were randomly selected, and one group was primed in a way that raised the mental construct of grit. This group was primed with a writing prompt asking them to recall and describe a time that they, or a family member, worked hard to achieve a goal under difficult circumstances.
The prime was effective at eliciting grit, because treated participants then scored higher on the Short Grit Scale questionnaire (Duckworth and Quinn 2009). The scientists could then isolate the effects of grit, when comparing the individuals who engage in the grit prime with those who did not.
To see how grit impacted investing behaviour, they then conducted two different experiments.
Experiment 1 : Grit and loss aversion.
Loss aversion, or prospect theory, was first coined by Nobel Prize-winning psychologist Daniel Kahneman; and it is a key part of behavioural finance – which helps us to understand why investors have a deep-seated instinctual impulse to avoid pain.
Kahneman discovered that the prospective pain of losing is about double the joy of winning. A simple example to understand this concept is to acknowledge that the pain of losing $100 is often far greater than the joy gained in finding $100.
In terms of investing behaviour, Doctor Omar Aguilar cautions that “Loss aversion can result in clients avoiding risk, leading to overly conservative portfolios that do not deliver the returns they need to achieve their goals. It can also push clients to sell during a stock market downturn simply to avoid further losses - which could mean they miss out on gains when the stocks they have sold rebound.”
The good news is that Bazley et al. found that grit positively affected the preferences of individuals; with results showing that grit reduced tendencies towards loss aversion.
Omar Aguilar, Ph.D. suggests that by teaching investors about loss aversion that we can encourage more rational investment decision making processes.
He goes on to elaborate that “Loss aversion is a major reason why so many investors underperform the market. For example, in 2018, a year that saw two sizable market corrections, the average investor lost twice as much as the S&P 500® Index, according to the financial research company DALBAR.1 This disparity can largely be attributed to investors selling stocks out of fear of further losses and consequently missing out on market rebounds.”
Which leads us to caution that if for any reason you are considering selling investments, please be sure to do your research and understand why you are considering selling up. If you don’t need the money, for say a house deposit or to live off in retirement, then be sure to check if your investments are simply down because the market is down, or have investments dropped because of company-specific issues that are unlikely to be resolved?
Regardless of whether you hold individual shares or funds, it’s important to clearly establish the factors that contribute to movements in prices. The worst thing an investor could do is to sell a good investment, that is down purely because the market is down. Some experts would even argue that with the correct due diligence, a market dip can be a good time to buy more of a particular investment – if an ‘on sale’ mentality is applied.
Where grit comes in handy is in removing bias towards selecting conservative investments in order to avoid risk; or conversely holding stocks in the hopes they will recover, despite research you may have done that suggests an unlikely recovery.
Experiment 2: Grit and disposition effects
Secondly, Bazley et al. looked at the disposition effect – which is where an investor has a tendency to prematurely sell assets that on paper have made some financial gains, whilst holding onto assets that are losing money. The disposition effect means the investor is enticed to cash in on gains (rather than realising losses).
The study predicted that “the core element of grit is related to how an individual responds to setbacks. Therefore, grit should be mitigating the disposition effect by primarily affecting the willingness to realize losses as opposed to realizing gains”.
Bazley et al. discovered that grit affects investor behaviour. Their findings concluded that grit reduces participants’ tendency to trade according to the disposition effect. By increasing their willingness to realize losses, participants treated with the grit prompt, tended to earn higher portfolio returns and not feel as tempted to sell an asset generating returns prematurely.
Is grit good for investing?
By priming some participants with grit constructs – they in turn saw diminishing loss aversion, and gritty investors exhibited a lower disposition effect. Ultimately their results suggested that interventions cultivating grit could improve households’ financial outcomes.
Did grit impact frequency or diversification?
It’s worth noting that Bazley’s team found no evidence that grit affects portfolio diversification or the overall frequency of buying and selling stocks. Overall, their study highlighted that diversity in portfolio choices across individuals may be rooted in differences in personality. They concluded that “the relation between grit and loss aversion cannot be explained by traditional determinants of economic choice, emotions, or alternative dimensions of personality”.
Grit and investor lifecycles
It’s exciting to note that these findings offer a potential mechanism through which household financial decisions could be improved. Bazley et al. state “since personality traits are malleable over an individual’s lifetime, interventions that target elements of personality, such as grit, may promote better financial decisions throughout the life cycle of investors”.
What a wonderful investing insight this is, given the markets always bounce up and down in the short term; yet generally over the longer term those who persist in saving and sticking to long-term plans can become the ones with the most wealth. If priming for grit can be used as mechanism to improve financial decision making, this is surely a good thing.
Getting more gritty.
According to Duckworth “Grit is not developed in isolation but in a context. And culture is a critical element of that process”. Duckworth comments that “Shared beliefs, values, and rituals at the national, local, and family levels all can contribute.”
So, if you want to be grittier, more humble, or more anything, you need to find a place where that is more the norm.
Duckworth believes that grit can be fostered both internally and externally. You can grow your grit “from the inside out”. Ways to do this on your own can include:
- Pursue your interests (outside of investing)
- Developing a habit of challenge-exceeding-skill practices. Get a little better every day.
- Connect your work to a purpose beyond yourself.
- Learn to hope when all seems lost.
- Get clear on your values
You can also grow your grit from “from the outside in” – by surrounding yourself with other gritty people – especially in the form of great friends, parents, teachers, coaches, bosses and mentors.
Duckwork also comments “There’s a wonderful harmony when you feel like what you’re pursuing aligns with your values and aligns with your interests, [because] it aligns with how you’re spending your time. And that’s what I find about very gritty people.” She also suggests “I think what it really is to be gritty is to have some alignment in your goals, and so you have the opposite of conflict — that you’re aerodynamically pursuing things with a lot of enthusiasm”.
Grit and optimism
Duckworth champions the thinking that those who persevere have meaning in their lives, and tend to interpret the world through an optimistic lens. She highlights that a sense of purpose may be more important than happiness or material wealth. “What really motivates people? More than money, honestly, it’s mattering,” Duckworth said. “It’s mattering and being useful and being appreciated by other people.”. She also highlights that “There is a positive correlation between grit and kindness, gratitude, empathy, curiosity, and more,” which we are huge fans of here at Flint.
When it comes to investing, we now know that gritty people are less susceptible to issues such as loss aversion - because grit reframes the way they perceive loss.
It’s not that their investing activity in itself is gritty; it’s more that their mentality and framing around long term goals helps them to select different financial outcomes.
If you’ve read our other articles, it will come as no surprise that we are big believers of investing for the long term. Generally speaking a ‘buy and hold’ strategy is considered effective, when aligned with your personal investment goals and time horizon. However, if you have lost confidence in an investment product or fund manager - especially if they’ve specifically demonstrated poor long-term performance (as opposed to a market downturn) - Grit can help you make the hard call to get rid of that holding and create opportunities to put your money in a better place.
If you’re researching fund managers - look out for historical moments where a fund manager, or it’s key personnel, may have had opportunities to potentially become more gritty. This could be outside of their employment. While it’s a hard thing to measure, it’s worth considering those who demonstrate grit – because they may potentially navigate upcoming economic climates in a less emotional manner.
If you are a fund manager reading this - you may like to bolster your team from the temptations of loss aversion, by priming your staff to recall a time where they have overcome a challenging situation. When employing new staff - it could be interesting to see who ranks well for grit.
And if you are an investor, with a mix of managed funds and/or other investments (such as shares) - you may like to try the same tips too: by giving yourself permission to recall a time you worked hard to achieve a goal during difficult circumstances.
We realise that the above is not a fool-proof plan to completely avoid loss aversion, however we hope it helps you to dial down emotional responses and make informed decisions in a more constructive manner.
As always, there will be times where good judgement will play into the investment decisions that you make – and this is where wit can still be a valuable trait, when deciding if an investment product continues to be right for your age, stage and goals trajectory.
Happy gritty investing!
IMPORTANT NOTICE AND DISCLAIMER:
All content shared is of a general nature, current to the time it was penned, and is not financial advice. Before making any investment decisions, please be sure you have completed full due diligence. This should include reading the product disclosure statement (PDS), considering fees and taxation, identifying your time horizons, and understanding the performance history and reputation of the investments you are considering.
Please note: When investing you are not guaranteed to make money (and on occasion you may lose some or all of the money you began with). Seek independent advice to establish if an investment is suitable for your financial situation and long-term wealth generation goals.
Grit, Loss Aversion and Investor Behavior study ; Decision Lab on Disposition Effect ; Grit - by Angela Duckworth ; Angela Duckworth FAQs ; Omar Aguilar Ph.D on Loss Aversion ; Investing success and Grit ; Berkeley study ; Investopedia on Prospect Theory ; Money King NZ : Sell or switch article ; Investopedia on investment goals ; Setting investment goals