In this episode, I’m joined by Carl Richards, a Certified Financial Planner (CFP®) and creator of the Sketch Guy column, appearing weekly in The New York Times since 2010.
Listen now and learn:
- How investors fall victim to the behavior gap
- What it means to do real financial planning
- The best way to avoid “The Big Mistake”
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Show Notes
For Episode 100 of The Long Term Investor, I was super excited to be joined by Carl Richards, a Certified Financial Planner (CFP®) and creator of the Sketch Guy column, appearing weekly in The New York Times since 2010.
Through his simple sketches, Carl makes complex financial concepts easy to understand. And his sketches also serve as the foundation for his two books:
- The Behavior Gap: Simple Ways to Stop Doing Dumb Things with Money
- The One-Page Financial Plan: A Simple Way to Be Smart About Your Money
In this episode, I ask Carl to talk about some of my favorite sketches and what real financial advice means.
Here are my notes from the conversation.
What is the Behavior Gap? (2:30)
One of Carl’s earliest sketches is a bar chart, with one bar labeled “investment returns” that is towering over a second bar labeled “investor returns.” The difference in the size of the two bars is labeled “Behavior Gap.”
See the original sketch: Stop worrying about investments, become a better investor
Imagine if you opened the newspaper, and there was an advertisement for a mutual fund that had a return of 10% a year for the last 10 years. That’s the investment return. To earn that return, you’d have to invest at the beginning of the period and leave that investment alone for the entire period – so no adding or subtracting from your investment.
The problem is that most people don’t invest that way. Most investors are constantly moving money around, often buying investments that have done well recently and selling things that have fallen short of our expectations. This behavior subtracts from the investor returns. And investor returns are further reduced by fees and taxes.
So early in his career, Carl labeled this well-intentioned search for the best investment that naturally leads to behavior that costs us money as the Behavior Gap.
But what I find most interesting is how Carl thinks about it today…The Behavior Gap is any well-intentioned behavior that produces a suboptimal result.
The example Carl gives is that a person might make the well-intentioned choice to be frugal—after all, traditional personal finance tells us to save save save—but that might cause conflict at home with your loved ones or you struggle to enjoy your wealth in retirement.
It’s a really great way to acknowledge that our very natural human behavior leads to suboptimal decisions beyond just investing. There’s certainly no reason to feel bad about it, but it’s important for you to realize how our natural human instincts usually nudge us in the wrong direction with money decisions.
Why Investors Get Distracted (5:45)
Many of those human instincts that make it difficult for us to make good decisions with our money are the same instincts that kept us alive as a species. We want to get away from things that cause pain and seek things that give us pleasure.
See the original sketch: Pain of Loss > Pleasure of Gain…Does that make sense?
The way this translates in the investing world is when you turn on CNBC, which Carl refers to as “the financial pornography network,” and see people riled up about market movements. There is an excitement about buying and selling. There is an urgency to everything. As a result, the difference between noise and relevant information is blurred.
See the original sketch: Sick of personal finance noise? Tune it out.
Imagine you hear on TV that the market is going to experience losses. Then you go out with friends who are saying the same thing. Not only is there the threat of something bad—something us humans are hardwired to avoid—but our human nature makes us fearful of being separated from the herd.
Even if we know that financial media is mostly noise, we are wired to pay attention to things that appear novel or dangerous.
What Investors Need When Markets Are Scary (9:05)
As someone that is regularly coaching investors through difficult markets, one of my favorite sketches from Carl has three bars under the title of: “What I need during a scary market.” The biggest bar is “Hugs.” The next biggest bar is less than half the size and it’s labeled “Facts.” The last bar, “Lectures,” goes in the opposite direction because it doesn’t help at all.
See the original sketch: Scary markets got you down? Don’t run. Just hug.
Again, let’s transport back to the early days of our species…If we hear a rustle in the bushes, we don’t have time to calculate the probability of the rustling being a lion versus the wind—we just have to run. When I think of that scenario as I speak with nervous clients, I know that it isn’t always helpful to say, “that’s obviously not a lion because lions don’t live here.”
Those facts, while true, aren’t always helpful. Investing can be scary and trying to sort out everything can be confusing. That’s why this has always been one of my favorite sketches.
When I asked Carl about his experiences that led to drawing it. He explains that even when you have a well-designed portfolio that is specifically tailored to your goals and values, it’s reasonable to get nervous and think about selling this long-term portfolio. We can agree that is an irrational conclusion, but the last thing anyone that’s in the middle of making an irrational decision needs is to be reasoned with (Carl notes that parents of teenagers know this all too well).
Financial professionals have a long history of pointing out irrationalities rather than empathizing with their clients. In reality, Carl suggests that it should be “hugs first, facts later.”
When people are nervous or scared, their brains are wired to think emotionally and not logically, so the best thing an advisor can do is create space to understand the emotions. Once that has happened, then it is more appropriate to review the facts of what has happened and how it affects your financial plan.
People think good money decisions are only mathematically driven, but your financial plan (if done correctly) creates relevance to the mathematics of it all by linking your money to your values and goals.
Real Financial Planning (15:30)
At the top of Carl’s one-page financial plan is his statement of financial purpose. The statement that answers, “Why is money important?”
Carl suggests that if you work with an advisor, ask them to guide you through this conversation. If you don’t have an advisor, have this conversation with a friend or spouse.
Carl shares an example of a couple he worked with years ago. The wife was a hard-charging emergency room doctor that first said that money was important to her because of the freedom it creates.
But Carl asked, “why is freedom important to you?” To this, she answered: “flexibility.”
Flexibility can mean different things to different people, so Carl kept digging until the answer eventually became “time.”
But when Carl asked why time was important, the answer was “I just want to have a family and I haven’t even had time to think about it.”
When you have an anchor point, it makes it easier to talk about how to invest, how much to save, what type of insurance you need. Once you understand why money is important to you, only then can you begin doing real financial planning.
One of Carl’s sketches is a Venn diagram. One of the overlapping circles is labeled “use of money” and the other is “values.” The overlapping section of the Venn diagram is labeled “real financial planning.”
See the original sketch: What’s important about money to you?
Carl defines “real financial planning” as aligning your use of capital (capital meaning time, money, energy, and attention) with what is important to you.
A quick gut check for how well these things are currently aligned is to review your checkbook and your calendar. Do the items show alignment in your use of capital and what’s important to you?
In the real world, sometimes the two circles within the Venn diagram have a gap between them. There may even be times in life when they perfectly overlap. It’s a never-ending process and real financial planning can help ensure there remains some overlap at all times.
Getting Ahead vs. Having Enough (22:30)
There are a lot of successful people out there who make a lot of money, save a lot of money, maybe they use an advisor, maybe they don’t. But there isn’t a clearly defined end game.
One of Carl’s sketches has one bar labeled “Trying to get ahead” that stretches out to the top of the page and a second far smaller bar labeled “Having enough.” The difference between the two bars is labeled “money needed.”
See the original sketch: Getting Ahead vs. Having Enough
In my experience, many people struggle to discover what enough means to them. Carl suggests that enough is not a destination. Instead, enough is just something you have to be.
Anyone that assigns a number to “enough” is never satisfied once they reach it. The hedonic treadmill means our goalposts are always moving.
Carl notes that research shows that decoupling your emotional well-being from your level of wealth is important to understand the concept of “enough.” For those in the lower third of emotional well-being, there is no link between money and happiness after a certain income level.
But for those that are in the top third of emotional well-being, there is a link between more money and happiness. Perhaps that’s because people with high emotional well-being know how to spend that money in a manner that increases happiness.
Consequently, Carl suggests we need to decouple our emotional well-being from money in order to figure out what is enough. A certain amount of money makes conditions more favorable—there’s no doubt about it—but more money won’t fix anything if you’re miserable to begin with.
The Value of a Real Financial Advisor (28:00)
If you want to work with what Carl refers to as “a real financial advisor,” the best way to identify one is to observe the type of questions being asked in a first meeting. Real financial advisors take the time to diagnose before prescribing.
Carl gives a great example of getting a prescription from a doctor that hasn’t thoroughly diagnosed you versus one who has that I won’t attempt to summarize, but it’s worth listening to.
A real financial advisor will spend the first meeting asking questions and listening so that they can learn about your specific situation. It’s tempting to want answers in that first meeting, even if they’re tentative answers, but really you should want to feel diagnosed.
It’s hard to argue that people wouldn’t benefit from professional advice in any endeavor—not just investing. I’ve noticed people focus on the tactics an advisor offers and executes, but it’s so much more than that.
The final sketch we discuss has a large box with the words “Your Advisor” resting between the words “You” and “The Big Mistake.”
See original sketch: The Value of an Advisor
Carl suspects that people who don’t see the value of a real financial advisor probably have only run into fake ones in the past. He jokes that real financial advisors are like a secret society in that they’re hard to find. They’re not making a bunch of noise like the fake ones. They’re just busy doing professional work.
The sketch above was born out of an experience Carl had on his book tour when someone was surprised that he himself had a financial advisor. They wondered why they should read his book if he needed an advisor himself.
To that question, he explained three reasons why he had an advisor: (1) to help clarify his goals, (2) remind him of what’s important to him when he’s thinking about doing something silly, and (3) to stand between him and doing something stupid.
Carl suggests that you want an advisor to be the thing between you and stupid, but he toned down the sketch to say “the big mistake.”
A real financial advisor would struggle to explain in advance the thing they’re going to help you avoid. But when they do help you avoid it, it’s big.
We all have blind spots that, by definition, you can’t see on your own. A real financial advisor can help you see them and avoid the big mistakes that come with them.
Resources:
- The Behavior Gap: Simple Ways to Stop Doing Dumb Things with Money
- The One-Page Financial Plan: A Simple Way to Be Smart About Your Money
- The original sketch: Stop worrying about investments, become a better investor
- The original sketch: Pain of Loss > Pleasure of Gain…Does that make sense?
- The original sketch: Sick of personal finance noise? Tune it out.
- The original sketch: Scary markets got you down? Don’t run. Just hug.
- The original sketch: What’s important about money to you?
- The original sketch: Getting Ahead vs. Having Enough
- The original sketch: The Value of an Advisor
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