Here's What Influences How Real People Invest Their Money

Spoiler: It's not stock market volatility

Your asset allocation—how much you invest in risky assets like stocks vs. safer assets like bonds—is one of the most important decisions you’ll make as an investor.

Everyone and their dog has advice on how you should allocate the assets in your portfolio. A recent survey conducted by (Choi, Robertson 2020) asked 1,013 retail investors in the U.S. what drove their decisions on how to invest their money.

In this post, I review their answers and provide some tips on how to use this information to make better investment decisions.

It always starts with income

If you type in “how to allocate my investments” into Google, you’ll get a bunch of generic statements you’ve heard a million times before, like “consider your risk tolerance and time horizon.”

But, the survey found that one of the most important factors in determining your asset allocation is your income.

Specifically,

1. How you make

2. How secure your income is

3. How likely you are to be sick or injured for a prolonged period of time

In my book, The Rational Investor, I discuss in detail why your income is the most important factor to consider when determining your asset allocation.

Think of your total wealth as financial wealth + human capital.

• Financial wealth is your assets like cash, stocks, bonds, and real estate.

• Human capital refers to how much more income you will earn for the rest of your career.

Ask yourself questions like:

• How many paychecks will I collect before I retire?

• By what amount will my income increase each year?

• How secure is my job?

• How correlated is my income to the stock market?

• What is the likelihood that I will be unable to earn income for a prolonged period due to injury or illness?

People who make a lot of money and feel confident in the stability of their future income feel much more confident to invest aggressively in the stock market.

How homeownership factors in

The second most important decision in your financial life is where you choose to live and whether you own or buy your home.

An interesting finding in the survey was that homeowners invest less of their assets in the stock market than renters.

The researchers conducting the survey suggest that homeowners view their home as a hedge against stock market risk, and since they have equity there, they don’t feel the need to invest as aggressively.

If you prescribe to the economic theory of fungible money, you believe wealth is wealth, and it does not matter if your net worth comes from your home or a portfolio of stocks. Renters don’t have home equity, so building equity in their portfolios is even more important.

In a past post, I wrote about research that suggests homeowners with large mortgage payments invest more aggressively in stocks than renters. While this may seem at odds, it is not as large mortgages indicate lower equity in their homes.

Here’s a more detailed breakdown of how homeownership and mortgages impact asset allocation:

Financial literacy, self-confidence, and access to trusted investment advice

The survey found that low trust in the stock market, fear of loss, a lack of knowledge about how to invest, and a lack of trustworthy investment advice were significant factors influencing investment choices.

All of these issues are interconnected and can be partially addressed through financial literacy.

The less you understand about how the stock market works, the more likely you are to:

• Believe the stock market is “Rigged”

• Feel terrified every time the market dips

• Be able to determine what sources of investment advice you can trust

I have written dozens of articles reviewing research and simplifying investments. If you want to learn more about investing, go binge-read those articles here.

Past experience influences future expectations

Research has shown that your past experience in the stock market is a driving force that helps determine how you invest your money in the future.

If you lost a huge amount of money in your portfolio during the financial crisis or the COVID market crash, you’d be less likely to invest in the stock market in the future.

Your past experience in the market drives your beliefs about where the stock market will go in the future. If your experience has been bad, you’re more likely to think the future of the stock market is bleak. If you believe that, then you will obviously invest less of your money in the market.

Of course, your beliefs and feelings have zero impact on what will happen in the stock market—but as the saying goes, “perception is reality.”

Here’s what (surprisingly) didn’t matter

The survey found that factors such as the risk premium, which is the difference in returns between stocks and risk-free assets, and stock market volatility were not important factors in determining investor asset allocation.

Another surprising and hopeful finding was that advice from friends, the media, and rules of thumb were not significant factors in determining an individual's allocation to stocks. As I cover in my Calling Financial Bull$hit series, the media, friends, and rules of thumb often provide terrible investment advice.

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I want to hear from you

What are some of the issues you consider when deciding how much of your money to invest in the stock market?

Is your income or your confidence in your investment knowledge a bigger factor?

Let me know in the comments.

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This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.