Cultural Influences on Financial Decisions
The financial decisions made by an investor are actually influenced by several factors that are present in their thought process. We have discussed about the rational aspects of traditional financial theory. We have also discussed about emotional aspects and behavioral biases in the previous articles. However, emotions are not the only thing that impact behavior. Culture is a strong sociological force which is always silently shaping the actions that we take in the background.
It is a known factor that a persons investment decisions are influenced by their risk appetite. Their risk appetite is influenced by many factors. For example, a person with a stable job may be more comfortable in taking risks as compared to someone who is not very sure about their job. Similarly, the level of wealth and security that an investor already has also has a huge influence on their risk appetite.
However, factors such as risk appetite are also deeply influenced by culture. This means that two investors with the same wealth and job certainty in different parts of the world will react very differently to risk-taking.
In this article, we will have a closer look at how cultural factors affect the behavior of investors.
- Culture Influences the Savings Rate: Individuals invest only after they save money. Hence, savings can be said to be a precursor to investments. Hence, if there are more savings, the investments will also be more. Culture has a huge impact on the savings rate. This is why culture also indirectly has a huge impact on investments. For example, people in Western countries tend to save less money since societies are more consumerist in nature. On the other hand, people in Asian countries such as China tend to save a bigger portion of their income for the future. This may be because these countries have seen rampant poverty in the not so recent past. Hence, the tendency to save money has been ingrained in their culture.
- Culture Influences the Asset Class: Cultural factors also have a huge influence on the asset class, which is chosen by individuals in order to make an investment. For instance, in most Western countries, homeownership is synonymous with marriage. It is almost as if homeownership is a rite of passage. This is the reason why real estate is the preferred asset class for most young people in western countries. People in their late twenties and early thirties actually use other asset classes as a temporary vehicle. Even if they invest in stocks or bonds, the investments are not long term. They are going to pull that money out in the short run and take out a mortgage. Similarly, in Asian countries such as India and China, there is a cultural need to buy large amounts of gold.
Gold is seen as a status symbol and is also used in large quantities in religious rituals. This is why there is a large amount of gold in this region. The bottom line is that a large number of investors choose a certain asset class because of purely cultural reasons. They do not evaluate whether real estate is giving a higher yield as compared to gold. They are not trying to maximize their monetary returns. Instead, they are simply trying to meet their social needs. For instance, stocks and bonds are unlikely to be used as wedding gifts in India or China.
- Culture Influences the Time Frame: Financial practitioners consider investments in mathematical terms. However, for the investor, they are a means to an end. An investment that provides the best returns is no good if it provides returns after the social need for it has passed. People are often investing with a particular goal in mind. They have money set aside for their house, their kids education and marriage, their retirement, etc. All these events take place within a certain time frame. This is the reason why the investment time frame is also decided by cultural reasons. For instance, if a person wants to save for their kids college and their kid is five years away from a college education, then by default, their investment horizon becomes five years. Hence, they cannot choose a long term asset class like equity, even if equity provides better returns in the long run.
- Superstitions: Another important point to be noted is that culture plays an important role even if it is irrational. For instance, in western countries, Friday the thirteenth is considered to be unlucky. This is the reason that historically returns for Friday the thirteenth have been lower. On the other hand, Indians believe that certain days are auspicious for making big purchases. This is the reason that asset classes like gold and real estate see a spurt on these particular days. There are various other superstitions that make no sense when you think about them logically. However, these superstitions tend to have a huge influence on the financial and investment markets in a particular region.
The bottom line is that cultural forces are always working in the background. Investment decisions are basically made by human beings, who are cultural beings by definition. They live in societies where acting in a certain way has become the norm. Human beings see value in conforming to those norms, and hence their social behavior is predictable.
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