Does having a lot of money make an investor more rational? Yes, but only to a certain extent

Cognitive biases are less pronounced among managers of large investment funds. However, this applies only to certain biases, and it does not necessarily mean that having a lot of money automatically makes a person more rational. This is the conclusion reached by researchers Richard Harris of the University of Bristol and Murat Mazibash of the University of Dundee in a new joint study. The reason for this limitation may not lie in the managers’ particular psychological resilience or even in their accumulated experience. Oninvest investigated why this happens and what lessons retail investors can learn from it.

For their study, the authors analyzed nearly 187,000 funds across various asset classes, investment styles, and regions. The sample included data from 1990 to 2022 on funds with more than $100 billion in assets under management. Based on the distributions of returns, the researchers assessed behavioral parameters related to the perception of gains, losses, and probabilities. In this section, the researchers drew on prospect theory: individuals evaluate financial outcomes not in isolation but relative to a specific reference point.

For one investor, a loss is a decrease in an asset’s value relative to its purchase price; for another, it is a deviation from the index’s return; for a third, it is the profit they expected but did not receive. The specific point of reference—the starting point from which we “base our decisions”—ultimately influences the decision.

However, the researchers did not directly observe the managers’ trades or examine the composition of the portfolios; instead, they worked solely with data on the funds’ returns. Therefore, the study is more about reconstructing a behavioral profile.

On average, the managers in Harris and Mazibash’s sample exhibited the typical patterns described in behavioral economics: loss aversion, diminishing sensitivity to subsequent changes in outcomes, and bias in the assessment of event probabilities. Moreover, in the model used, a loss of a certain size, on average, has a stronger effect on a manager’s subjective assessment of financial performance than a profit of the same size. According to the authors’ interpretation, this means that, on average, managers exhibit a lower propensity for risk in loss situations.

The largest funds were also less susceptible to the temptation of unlikely wins: they were less likely to pursue a strategy that could yield very high returns but with a low probability of success. This tendency was more pronounced among smaller funds. The authors attribute this to the fact that large funds can afford a more diversified strategy and are less dependent on a single risky trade.

The researchers take their reasoning a step further: in their view, it is by no means certain that managers of the largest funds have a better understanding of the market. Perhaps they have decision-making tools that prevent emotions from getting the better of them. These might include a separate team of analysts who test a particular idea, pre-approved limits that prevent the excessive buildup of a losing position, an investment committee with all the required procedures in place, and so on. In other words, in such a system, rationality is, so to speak, built into the structure and procedures, rather than being left entirely up to one or two leaders.

However, even a large-scale system with well-established procedures does not fully guarantee a rational approach. The authors emphasize that the system should create conditions in which it is easier to make a rational decision and harder to deviate from it. In other words, the system is designed not to eliminate cognitive biases, but to control them.

Another finding of the study seems less logical: a fund manager’s tenure or experience turned out to be a much less important factor than the size of the fund. The differences between groups of managers with varying levels of experience were statistically significant, but small. At the same time, the variation among individual managers within the groups based on fund size was noticeable. In other words, the group with average tenure differed from the managers with the least experience in a number of parameters; however, this relationship was not linear: the most experienced managers did not always occupy the extreme positions.

In other words, work experience merely indicates how long a person has been in the workforce. On its own, it says nothing about how a person evaluates their own decisions and their effectiveness.

We usually think that professional experience implies a person’s ability to recognize mistakes, navigate market fluctuations, and cope with psychological pressure—at least internally. But as the study’s data suggests, it can also mean that a manager has simply been following the same habit for many years—and that habit isn’t always in the fund’s best interest.

For example, he may consistently seek confirmation of a decision he has already made, view past success as proof that his approach is correct, avoid actions that might force him to admit his own mistake, or rely on personal intuition when external oversight is needed. Essentially, these are the same cognitive biases, but they operate differently from those that a large fund’s management system has learned to manage.

The study shows that, on average, certain cognitive biases—which manifest in the behavior of fund managers—are less pronounced among the largest funds, suggesting that this may be linked to a more consistent decision-making process. In other words, processes are needed to make the emotional influence on the manager even more apparent and manageable before it begins to subtly affect their actions.

To do this, you should first visualize the transaction process in as much detail as possible: establish exit conditions in advance, consider arguments against proceeding, and distinguish between the quality of the process and the financial outcome. In other words, if a fund evaluates only the result, this can lead to risky habits and the role of sheer luck becoming the norm.

Ultimately, the infrastructure within the fund itself—the team of analysts, risk management, diversification, procedures, and the ability to weather temporary setbacks—may be just as important as the fund manager himself.

For individual investors, the lesson is that it is not so much the transactions themselves that matter, but rather how trading on the stock market is organized.

This article was AI-translated and verified by a human editor