When you buy a stock, what drives your decision-making? In a new study, academics ran a series of AI-driven interviews with over 1,500 investors from across the world about their stock-picking choices, and found 13 different factors (or what the paper calls “recurrent mechanisms”) that motivate decisions to invest in a particular company. Although there were some notable distinctions across regions and cultures, Fundamental Strength and Growth / Innovation proved to be far more common reasons than Valuation / Mispricing and Momentum. [i]

The researchers employed AI to conduct field interviews with a large group of investors situated in several countries (including the US, UK, India, and South Korea). There was also a broad spread of investable assets, with 42% of the sample between $1,000 and $499,999, 29% between $500,000 and $999,999, and 29% above $1m.

Participants engaged in open-ended, AI-led conversations designed to explore their rationale for stock purchases. A GPT model was then used to assess the responses and define “recurring decision patterns” or, in simple terms, the reasons why investors were buying stocks.

The process led to the identification of 13 mechanisms that commonly described the choices made by investors around individual company investments. They were ranked as follows:

1. Fundamental Strength (40.5%)*
2. Growth Innovation (37.6%)
3. Familiarity / Brand Effect (28.4%)
4. Blue Chip Comfort (28.1%)
5. Authority / Follow (18.6%)
6. Momentum (17.9%)
7. Confluence (14.6%)
8. Dividends (14.0%)
9. Social Copy (13.6%)
10. Valuation / Mispricing (13.6%)
11. Buy the Dip (12.5%)
12. ESG / Values (10.3%)
13. Technical Analysis (6.8%)

(The numbers in parentheses show the proportion of responses where a specific mechanism or rationale was identified.)

This is a fascinating study that I would recommend taking the time to read. I have some initial observations on the results:

Investors like to own stocks that are performing well right now:

If you had asked me, prior to reading the study, to predict its findings, I probably would have said that investors like to buy stocks that have good current profitability and positive sentiment around its prospects – consistent with Fundamental Strength. This plays into so many of our behavioural biases – most notably our desire to extrapolate, our focus on recent outcomes, and susceptibility to salient stories. What is more attractive to an investor than a high-profile stock with good recent results and a captivating narrative?

In addition to this result being unsurprising, it is also worrying that so many investors implicitly believe that they have an edge in judging the prospects of these types of companies.

Investors can’t resist a good growth story:

It is also unsurprising that investors have a preference for growth and innovation. While this may be somewhat exaggerated by market conditions in recent years, the desire to invest in innovative companies with the potential for abnormally high payoffs predates the more recent success of technology and AI-related names.

Investors are comfortable with what they know:

Investors like companies that have an established history and those which they may have personal experience with. There are some powerful heuristics at play here, both in the view that a long-established company may be lower risk, and in the tendency for people to judge a company’s prospects by how positive their own experience is with the product or service it offers. I would expect this factor to be far more common among private investors, where the depth and breadth of knowledge of the universe of stocks is very likely to be limited compared to professional investors.

There is good news for value investors:

Value investors will probably have mixed emotions reading this study – both despondent that Valuation / Mispricing does not rank highly among the reasons people buy stocks, and delighted at the opportunities that may arise because valuation does not rank highly. Value investing works (over time) because it is behaviourally difficult, and because we are predisposed to care more about other things (valuation only scores as highly as copying other people).

There is probably a stigma around momentum investing:

Momentum as a standalone factor only ranks sixth, but I think this understates how important recent returns are to investor decision-making. Performance momentum is inevitably deeply intertwined with Fundamental Strength, and I have a strong suspicion that people are likely to justify performance-chasing decisions as being driven by strong fundamentals. It sounds more compelling and robust to say that you have invested because of a company’s improving operational prospects, rather than because its price has gone up a lot recently.

There are significant cultural / regional differences:

There are some fascinating regional and cultural differences in the study. For example, Fundamental Strength is stronger in Japan (60%) than in the US (30%). Also, close to half of the responses in Japan were assessed to have Familiarity / Brand Effect as a meaningful contributor to stock decisions. The extent to which these are entrenched differences or reflective of more recent, localised market performance is
unclear, but it is undoubtedly interesting.

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Why are certain factors so influential in what stocks investors buy?

If we look through the underlying mechanisms described, there is a heavy behavioural influence on the largest contributors to stock picks – Fundamental Strength (extrapolation, outcome bias), Growth Innovation (lottery-ticket pay-offs, stories), and Brand Effect (familiarity). This seems to outweigh the influence of factors that have somewhat more evidence supporting them (such as Valuation / Mispricing and Momentum).

Of course, it is impossible to know with any level of confidence what drives our behaviour and this study only goes so far as to seek to identify the stated reasons for a stock purchase. This raises two intriguing questions:

– How significant is the gap between the stated reasons and the ‘real’ drivers of our investing behaviour?

– If the stated reasons are a fair reflection of the factors influencing our stock purchasing decisions, why do investors choose those factors? (Why is Fundamental Strength more important to us than Valuation? What is the appeal of dividends?)

Questions for another post.

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* The definition of Fundamental Strength is as follows: “Investors buy stocks when audited financial information indicates robust current performance, which, to investors invoking this mechanism, also signals high expected future returns.” Definitions for each of the mechanisms are provided in the full study.

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^[i] How Investors Pick Stocks: Global Evidence from 1,540 AI-Driven Field Interviews

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My first book has been published. The Intelligent Fund Investor explores the beliefs and behaviours that lead investors astray, and shows how we can make better decisions. You can get a copy here (UK) or here (US).

All opinions are my own, not that of my employer or anybody else. I am often wrong, and my future self will disagree with my present self at some point. Not investment advice.

It is that most wonderful time when asset managers publish their expectations for the coming year, so I have decided to lightly update my 2025 version of what all of these will say:

Here goes:

– There is no AI bubble (2026 special): Nobody is going to tell clients there is an equity market bubble, but the importance of being selective will be emphasised.

– Uncertainty will persist, diversification is critical: This will be framed as being particular to the year ahead, but is always true.

– Investors need to be nimble: This is the asset allocators’ version of ‘a stock picker’s market’.

– Investors need to be discerning: A stock picker’s market.

– The traditional approach to portfolio management might not work anymore: Just in case a reader is investing in an old fashioned, unsophisticated way. Yes, the 60/40 is still dead.

– Economic growth will be fine (but with some downside risks): This must be the case because 1: Economic growth is usually solid in any given year and 2: It is not a great idea to tell clients that there is a recession looming.   

– Prevailing performance trends are likely to continue but could change: The safest bet is always to say that what has been working recently will continue to perform well next year This makes readers feel comfortable and plays on the propensity of markets to trend / people to extrapolate. It is important, however, to mention something about the potential for a ‘broadening out’ or ‘reversal’ – just in case.

– Alternative asset classes look attractive: Coincidentally, they also happen to have high fees and are difficult to replicate passively.

– A current key structural theme will profoundly impact markets: AI is incredibly important, but look beyond the obvious winners.

– We are at a critical turning point. Something significant is changing in the world order / investment landscape – you need our help to navigate it safely. Whatever you do, don’t be complacent. (Probably AI, again). 

– We should be worried about a loosely-specified tail risk that the market is obsessing over: There is always some tail risk that is concerning investors – it needs to be mentioned even if nobody is quite sure if it is a genuine risk or what to do about it (fiscal sustainability for the second year running).

– Equities will perform well: This is both likely to be true in any given year and avoids panicking readers. (Adjust as appropriate for fixed income / private market outlooks).

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These annual documents are generally a good, tangible reminder that we are hopeless at forecasting and that financial markets are always a rotating cast of salient topics that feel urgent in the moment but have little predictable bearing on long-term outcomes.

To the extent that short-term issues matter at all, it will be the ones that nobody is expecting that will have a significant market impact.

If read for what they are – a gentle sales pitch with some interesting financial market observations – they are harmless enough, particularly if they, somewhat inadvertently, encourage readers to stay invested over the long-term. But we certainly don’t need to be acting on them and rest assured nobody will remember anything that is being foretold now in 12 months’ time.

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My first book has been published. The Intelligent Fund Investor explores the beliefs and behaviours that lead investors astray, and shows how we can make better decisions. You can get a copy here (UK) or here (US).

All opinions are my own, not that of my employer or anybody else. I am often wrong, and my future self will disagree with my present self at some point. Not investment advice.

There has been a lot of talk recently about whether there is a bubble in certain parts of the market, but this might be the wrong question. Perhaps we should instead be asking what we would do about it if there was one. Imagine if you – and only you – knew for certain that there was a bubble in US equities. What action would you take?

Let’s define some terms. You are managing a traditional multi-asset portfolio holding a globally diversified mix of assets for long-term growth. Through an unexpected dose of divinity, you know without any doubt that US equities are in the midst of an investment bubble – that is, valuations are unsustainably high relative to underlying fundamentals and will aggressively revert at some point.*

There is a catch, however. Your ability to see the future does not extend to timing. So, while you know a bubble exists, you have no idea when it will pop.

You know something will happen, but you don’t know when.

How would you adjust your asset allocation?**

For your personal portfolio the answer is probably straightforward: you remove most, if not all, of your US equity exposure and are comfortable being patient (perhaps you simply invest in non-US equity markets).

If, however, you manage money professionally for others, the answer is likely to be very different.

When a professional investor assesses an investment opportunity and decides how to size it, they think primarily about four things (or at least they should):

• The potential payoffs – the future returns in different scenarios.
  
• The probability of each payoff – how likely each return outcome is.
  
• The cost of being wrong – the impact if the assumed payoffs and probabilities prove incorrect.
  
• The need to survive – how much underperformance we can bear.

The final element – survival – is about understanding that being right isn’t always enough. It is about our ability to withstand the path to validation. It asks:

How can I size a position so that I don’t lose most of my assets, or my job, if it temporarily goes against me?

Drawdowns, whether in absolute terms or relative to a benchmark, are incredibly challenging. And it is not just their depth that matters, but their duration.

If you don’t scale your position for survival through time, then whether you are correct can become an irrelevance. That is why, for professional investors, even the enormous advantage of knowing without any doubt that US equities are in a dangerous bubble would not make allocation decisions easy — unless you also knew the timing.

Imagine you take the bold choice to reduce your exposure to US equities by three-quarters because of your bubble prescience. What if the US market outperforms for the next four years? You will appear completely wrong and probably lose a lot of clients, even though you possess an exceptionally valuable piece of foresight.

When managing a portfolio, sizing is all about survival or gauging your ‘portfolio pain threshold’ – for how long and by how much could you bear a decision appearing wrong, even if it is ultimately right?

This reality of professional investing can lead to behaviours that seem irrational — such as holding an asset you know is in a bubble — but are in fact ultra-rational within the context of surviving the unpredictable nature of markets.

This dynamic makes it essential that professional investors ensure their clients have clear expectations about the approach being adopting and the performance realities that come with it.

Unfortunately, no investor has advance warning of what will happen in the future. We must contend not only with the pain of short-term underperformance when we are right, but also with the uncomfortable truth that we could be completely wrong.

It doesn’t matter how confident we are in our investment thesis: if we don’t consider survival and understand our tolerance for portfolio pain, we might not be around to benefit even if we are ultimately vindicated.

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*This is not a view, just an example for the sake of the post.

** No options or instruments with convex pay-offs are allowed, as that spoils the game. The question is – how would you adjust your allocations in a simple fashion?

This is an excellent piece from alpha architect on why seeing the future wouldn’t stop an active manager getting fired.

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My first book has been published. The Intelligent Fund Investor explores the beliefs and behaviours that lead investors astray, and shows how we can make better decisions. You can get a copy here (UK) or here (US).

All opinions are my own, not that of my employer or anybody else. I am often wrong, and my future self will disagree with my present self at some point. Not investment advice.