How Culture Impacts Investment Behavior

According to the traditional view investing has to do with money so that one should expect that patience and risk attitudes depend on an investor's wealth and the economic environment in which he lives.

In such a world, an American investor would have the same risk aversion and patience as a German or Chinese investor if they had the same wealth and lived in similar economic environments (inflation, job security etc.). But is this really the case? Professor Thorsten Hens from the Swiss Finance Institute at the University of Zurich wanted to find out more. Together with Mei Wang and Marc Oliver Rieger, he has done a worldwide study on patience and risk aversion summarized in the White Paper "Behavioral Finance: The Psychology of Investing, in December 2014 with the support of Credit Suisse. This study proved that cultural background actually does matter. "We were surprised by how much culture drives individuals' investment behavior, even when control variables such as inflation rates or accumulated wealth were taken into account," Hens said.

7,000 Students Across 52 Countries Surveyed

Standardized questionnaires with 30 socioeconomic questions were handed out to nearly 7,000 undergraduates in economics in 52 countries around the world between 2007- and 2009. Only countries with more than 100 respondents were included in the study's results. The surveys were translated and adjusted into local currencies and local standards of living to make the replies as comparable as possible. "It was a huge effort. We, for example, had to exclude Chinese or European students studying at US universities, to make sure the replies would only reflect the cultural background of the US students," Hens explained.

Eastern European Investors Are More Risk Averse

The study showed the impact of cultural differences on investment behaviors and how an individual's cultural background can influence returns on the financial markets. "In collaboration with Nilufer Caliskan, I found evidence that the value premium – the difference between the expected returns of value stocks and growth stocks – is higher in countries with more impatient investors with a high risk aversion such as Romania, Lithuania and Russia. Investors from such a region require a higher value premium to hold value stocks," Hens said. In other words, Eastern European investors are willing to pay less for value stocks than for example those from Nordic countries, who are more patient and have a lower risk aversion. "A similar observation was made for the equity risk premium – the additional return that an investor expects from an equity compared to a risk-free financial instrument," Hens said. The equity premium is the lowest in Anglo-Saxon countries such as the US and the UK and the highest in emerging regions such as Latin America and Eastern Europe. In other words, investors in Anglo-Saxon countries are willing to pay more for equities than investors in other countries.

More "Ego-Traders" in the US Than Elsewhere

Another interesting finding was that market momentum is strongly correlated to the degree of individualism of the surveyed countries. "In individualistic countries, there are more 'ego-traders' seeking quick gains, leading to a higher market momentum," Hens said, citing the US as an example. In more patient countries, such as the Nordic countries and Germany, there are more value traders, who prefer to wait to earn higher returns rather than to cash in less today. The most impatient investors were found in Africa. The surveyed African students were the most likely to reply they preferred to have a payment of 340 US dollars this month, rather than 380 US dollars the following month. This can to some extent be explained by the region's relatively high inflation rates and low wealth, but cultural factors also play a role.

Americans and Africans With a Similar Risk Aversion

When examining the replies of the survey there were fewer similarities across comparable cultural regions than had been expected at the outset of the study. "I would have expected a greater correlation in the investment behavior among investors living in regions with similar economic conditions, but there was actually no pattern. There is, for instance, a very highrisk aversion in Eastern Europe. We conjectured a similar degree of risk aversion in Africa, another emerging market continent, but it turned out to have a much lower risk aversion in line with the Anglo-Saxon investors," said Andrea Cuomo, Head UHNWI Centro Sur at Credit Suisse, who was among the bank's experts reviewing the study.  Patience was the lowest in African countries and the highest in Northern Europe and Germany but Americans were rather impatient . "It was surprising to see that Americans are so impatient, despite living in an organized society and being so wealthy compared to other cultural regions," Professor Hens said. 

The Wealthiest Investors Are Less Guided by Emotions

In his daily work at the bank, Andrea Cuomo not only experiences that investment behaviors differ between cultural regions but also between client segments. "Cultural differences are more present in the high-net-worth than in the ultra-high-net-worth segment". A high-net-worth individual is an investor with investable assets exceeding 1 million USD and an ultra-high-net-worth individual (UHNWI), an investor with investable assets above 50 million USD. "Wealthier investors are inclined to follow investment policy statements more closely, while smaller portfolios tend to be more emotional," Cuomo noted. Home biases are also present in nearly all investment portfolios. "Latin American bonds is a very important sub-asset class in Latin American clients, less in European clients' portfolios," Cuomo added.

Advisory Process Adapted to Different Cultural Traits

Thorsten Hens believes, that financial institutions would benefit from taking these cultural differences into account when advising their clients. "European clients, for instance, like to delegate their investments and often go for discretionary mandates. Asian investors with a similar age and wealth profile do not like to delegate, usually preferring advisory mandates. Banks need to be aware of such cultural differences and differentiate their offering." At Credit Suisse for example, the advisory process already integrates the impact of cultural differences, and should diminish the mistakes linked to behavioral finance. Another tool used is the profiling of the risk tolerance of clients, an estimate of their emotional attitude with regard to portfolio management. These two tools give clients additional protection in terms of reducing the impact of behavioral finance biases.

Cultural Differences Likely to Level Off With Time

As the world's globalization continues, with an increasing number of students exposed to traditional finance, attending Western-style universities and adopting similar lifestyles, cultural differences are likely to level off with time. A study carried out by Geert Hofstede in 1979 and repeated by Thorsten Hens and his co-authors 30 years later points in this direction. "People have generally adopted a more American lifestyle, being more materialistic than 30 years ago. Variations are smaller and there is a tendency toward greater convergence. Lately, the emergence of the Internet has speeded up the globalization tremendously."