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Inheritance: identifying the genetic component of financial behavior

As financial creatures, we are magnificent mysteries.

What makes us savers or spenders, buyers or renters? Why do we play the stock market or safeguard our money in the bank? Why do we gravitate toward growth or value investments? Why do we trade too much, refuse to sell at a loss, fail to diversify, bet on lottery stocks or chase past performance—even when we know it’s wrong?

Each of the financial decisions in our lives is the result of innumerable—and sometimes unknowable—forces.

Now, for the first time, we do know that one of the most powerful of those forces is our DNA.

Stephan Siegel

Stephan Siegel

In a series of groundbreaking studies on the determinants of financial behavior, the Foster School’s Stephan Siegel has established that, on average, one-third of the variation between individuals is attributable to our genetic makeup.

These innate predispositions eclipse the effects of age, gender, health, income, education or even parenting. And they remain consistent in driving decisions throughout our lives.

“We find that genetic differences explain much more than socio-economic factors that prior research has proposed to explain differences in financial behavior,” says Siegel, an associate professor of finance and Evert McCabe Faculty Fellow at the University of Washington Foster School of Business. “Genetic differences matter throughout people’s lives, even in old age.”

Nature v. Nurture

How did a professor of finance find himself charting a new chapter in the field of behavioral genetics? Siegel’s trip down this particular rabbit hole began with a simple observation back in graduate school.

While working on a study of empirical asset pricing at Columbia University a decade ago, Siegel noticed that most finance models were constructed assuming that all investors are identical and could be collapsed into a single “representative agent” acting as proxy for the entire economy.

He began working on relaxing this assumption and allowing for investor heterogeneity that so obviously exists in the real world. But in addition to acknowledging that these differences exist across individuals, he became increasingly interested in knowing why they exist—what causes the variations that drive seemingly similar people to invest so dissimilarly.

Questions about the origins of human behavior were traditionally the domains of psychology and anthropology, wherein raged the age-old debate over the determining effects of nature versus nurture. Few in Siegel’s discipline had had ever asked how differences arise in risk attitudes or patience. And no economist had tried to measure the fundamental source of such variation.

But the question so compelled Siegel that he decided to detour from his original studies and search for a way to measure the source of an individual’s behavioral biases and risk and time preferences that determine financial decisions.

“It turns out,” he says, “that nature provides us a unique opportunity.”

Twinning

Siegel was introduced to the power of twin studies by the seminal work of Thomas Bouchard at the University of Minnesota. Bouchard and collaborators had produced compelling evidence on the heritability of a large number of personality traits and cognitive skills using data from the Minnesota Center for Twin and Family Research, the largest twin registry in the United States.

The technique is simple enough in concept. Identical twins share roughly 100 percent of their DNA. Fraternal twins share, on average, 50 percent of their DNA. So, if you compare the similarity of behavior between pairs of identical and fraternal twins, you can isolate the genetic component of that behavior.

That is, if you have enough twins to study. For Siegel, finding a suitable twin registry would not be enough. He also needed corresponding financial data for each set of siblings.

It happens that the Swedish Twin Registry, the world’s largest such database, has tracked more than 50,000 pairs of twins throughout their lives. And it also happens that the government of Sweden kept a comprehensive record of every financial transaction made by every tax-paying citizen until the abolishment of its national wealth tax in 2007.

“Amazingly, Statistics Sweden agreed to merge these two data sets for us,” Siegel says. “And we were able to observe exactly what 30,000 twins did in the financial domain: how much of their income they saved, how much they invested in risky assets, what investment biases they displayed.”

It was a data set of dreams.

Genes matter

Over the past several years, Siegel and primary co-author Henrik Cronqvist, a professor of finance at the China Europe International Business School, have systematically analyzed some of the most common financial decisions. In separate studies they considered savings rates, financial risk taking, investment style, real estate ownership, and a variety of investment biases including inadequate diversification, excessive trading, reluctance to sell at a loss, chasing past performance and trading in lottery stocks.

What they found, from comparing the behavioral correlations of identical and fraternal twins, was astoundingly consistent across all behaviors: 30 percent of the variation between individuals, on average, is attributable to genetic makeup.

And this consistency holds up over time. Separating the twin population into age groups demonstrated that maturity and the acquisition of personal experiences does not drive out a person’s genetic influence. Even comparing a small subset of twins who were raised apart produced very similar results.

Siegel, a native German who lives and works in the United States, notes that context is important. He studied Swedes. But other genetic studies suggest that less-constrained societies—such as America’s—could permit a more pronounced genetic effect. The more we’re allowed to “express ourselves,” the more our genes will express themselves.

The bottom line: more or less, heredity matters.

“A significant portion of our financial behavior is predetermined,” Siegel says. “And it stays throughout our lives.”

Surprisingly Indeterminate

But how big a deal is 30 percent? To put it into perspective, Siegel and Cronqvist estimate that the combined factors of age, gender, education, wealth and home ownership explain at most 15 percent of these behaviors. And parenting—the crux of the “nurture” camp—is shown to have little and diminishing impact on a person’s financial proclivities as we get older. “Parents do matter early in a person’s financial life,” Siegel says, “but less and less over time.”

He adds that the effect of education—whether you’re talking general level of schooling or dedicated financial literacy initiative—on financial behavior is difficult to evaluate.

What Siegel can say from his existing work is that findings of a positive correlation between education and financial behavior do not necessarily represent a causal effect. For example, when one identical twin has graduated college and the other has not, he observes no significant effect of the college education on financial sophistication (or the quality of financial decision making).

If there’s a common conclusion from these discoveries, it’s that the genetic component of financial decisions is comparatively strong, consistent, and not easily altered.

Siegel has focused on individual behaviors. But some of those behaviors have economy-wide ramifications as well. Particularly troubling are the intractable investing biases that afflict so many of us. Learning from our mistakes appears to be a challenge.

“It may explain why we see a repeating pattern of bubbles and bursts in financial history,” he says. “These biases are very persistent.”

The “driverless” car

As a public policy issue, genetic inequality in the financial realm might prove too controversial to touch.

But Siegel believes that better financial decisions—at least for retail investors—will come from innovations in the financial services industry. He predicts that asset management will evolve into a service that everyone can afford, personalized but automated, using data mining technologies and complex algorithms to deliver comprehensive analyses and objective advice on what we should do with our money to optimize our lives.

The revolution will be computerized.

And, in fact, it’s already begun. New industry players such as Betterment, Wealthfront and Financial Engines offer an automated alternative to flesh-and-blood financial advising. And it’s probably a matter of time before Google, Amazon and the other masters of Big Data and cognitive computing enter the market.

The key is data and the computer algorithms to make sense of it. In the not-so-fictional future, Siegel envisions a highly intelligent system of machine learning that will stitch together a complete and accurate profile of us from our expansive datatrace of actions and transactions. Eventually our decoded personal genome and cognitive functioning may enter into the equation as well.

“We are getting much better at measuring things that we once believed immeasurable,” Siegel says. “Our genes. Our brains. Our behaviors. It’s all just data that can be registered, analyzed and acted on.”

If this all sounds a bit too much like Orwell’s cautionary Big Brother, Siegel tends to agree. But the truth is, we’re becoming more comfortable with—and reliant on—automation technologies that earn our trust. For Siegel’s future of financial advising, Google Maps is a good analogy. An even better one is the driverless car, which will know where you are, where you want to go, and the most efficient way to get there—bypassing external obstacles and our own innate biases along the way. No matter how good we think we are behind the wheel, the self-driving car will be better.

“That’s the equivalent change I expect in financial services,” Siegel says.

The rest of the story

The noted behavioral geneticist Nancy Segal says that the studies of Siegel and Cronqvist are a welcomed extension of her field, which has focused on cognitive abilities, medical conditions and other behaviors. “It’s nice to see that twin research has such broad applicability,” says Segal, a professor of developmental psychology at Cal State Fullerton. “Their work can help us to understand and guide investment and other financial decisions, and to better understand our choices, which are influenced—in part but not fully—by genetic factors.”

To that point, there is more than simple heredity to the financial story of us. “While genetic effects are important,” Siegel says, “they are not destiny.”

Everything he’s learned about the determinants of financial behaviors—heredity, parenting, education and more—still leaves a lot of mystery. At least 50 percent of the variation between people is shaped by the individual and idiosyncratic experiences of our lives.

This unknown is where Siegel is headed next. It turns out that twins contain the answers to some experiential questions, too. One of his recent studies finds that our formative-years exposure to hard times or happy days affects our inclination to invest in value or growth stocks. Another shows that birth weight and in-vitro exposure to testosterone predict an individual’s risk tolerance throughout life.

There are so many experiences yet to explore before we know the full picture of what makes us do what we do with our money. Plenty of work ahead for Siegel and the growing cohort of scholars on the frontiers of behavioral finance.

“When we started down this path, nobody had looked at the genetic drivers of financial behavior, which has proved to be a worthwhile area of study,” Siegel says. “But financial behavior is not deterministic. There are other factors at work, too. Your life course matters in your financial decisions.

“A strong factor is inherited, but there’s always room for variation.”

Siegel hopes to explore future studies using the University of Washington Twin Registry, a community-based database of nearly 9,500 local twin pairs.