Dr. Daniel Crosby, a psychologist, and behavioral finance expert joins the show to talk about the things we get wrong with investing and how to get them right.
Listen now and learn:
- What most people misunderstand about investing
- The 3 things required to change financial behavior
- How your environment can dramatically alter the decisions you make
Listen to the show now or read the in-depth show notes below.
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Show Notes
Dr. Daniel Crosby is a psychologist and behavioral finance expert who helps organizations understand the intersection of mind and markets. Dr. Crosby’s first book, Personal Benchmark: Integrating Behavioral Finance and Investment Management, was a New York Times bestseller.
His second book, The Laws of Wealth, was named the best investment book of 2017 by the Axiom Business Book Awards and has been translated into 7 languages.
His latest work, The Behavioral Investor, is a comprehensive look at the neurology, physiology, and psychology of sound financial decision-making.
In our conversation, we talk about:
- What most people misunderstand about investing
- The 3 things required to change financial behavior
- How your environment can dramatically alter the decisions you make
Here are my notes from our conversation.
02:45 — What do most people misunderstand about investing?
When most people are looking for the drivers of investment returns, they’re going to focus on things they can’t control. What’s happening in Ukraine? What’s the Fed going to do? What’s the economy going to do? These are things they can’t control and can’t be forecasted, so it’s a futile exercise and one that leaves people feeling helpless.
The best predictor of financial outcomes is your adherence to a couple of very basic unsexy principles that are within your control (costs, regularly contributing to your investments, staying the course in good times and bad, etc).
04:25 — The 3 Things Required to Change Financial Behavior
While your behavior is certainly within your control, you can’t necessarily do it alone.
We’re wired for immediacy pleasure and immediate certainty. But everything required of getting our financial house in order and growing our wealth runs contrary to that human need for immediacy.
People don’t approach behavior change holistically. Daniel has three E’s that he thinks are required to change financial behavior.
- Education. We need to know how markets work. We need to know how personal finance works, education is sort of the foundational layer.
- Environment. You need a portfolio that is tailored to your risk preferences and your risk style so that you can stay the course (which is easier said than done).
- Encouragement. Even when we know the right thing to do, there’s going to come times in the lives of every investor where they’re tested and when they’re going to need someone to hold their hand to keep them invested and help them make the right decisions at critical junctions.
If you’re not being thoughtful about all three of these things, the odds of you doing the right thing when you’re wired to do the very wrong thing are very low.
7:15 — Guinea Worms and The Importance of Behavioral Intervention
Once people do enlist help, they’re sometimes shocked at the simplicity of the advice being given, they feel like it has to be more complex. Daniel Gives a wonderful example in The Laws of Wealth about guinea worms that I ask him to share.
He explains in the book how Guinea worms were decimating local economies because people weren’t able to work and it spread rapidly, but how it is the first time in human history that we eradicated a disease for which there was no cure.
Instead of there being a pill or shot, it was done through simple behavioral interventions. The same is true of financial misbehavior: there’s never going to be a pill or potion or perfectly weighted fund that’s going to keep us from doing stupid things.
But if you learn a handful of good behaviors, we can keep ourselves on a good path.
10:55 — Why Do Humans Get Excited By Money?
When writing the behavioral investor, Daniel looked at a lot of fMRI studies where they hook people up to brain scans and measure the amount of electrical activity in the brain when showing people different excitably stimuli. Researchers find that money has more excitatory power than drugs, sex, and rock n’ roll.
Why?
Money is the means by which we secure the sort of fundamental safety needs that we all have from just an evolutionary standpoint. It touches every run on Maslow’s hierarchy.
Everything from meeting the basic needs of life to measuring our own self-esteem, for better or worse, money’s implicated. And so, accordingly, it has a ton of excitatory power. And our ability to get goofy with money — or to become overwhelmed by our stress or our fear or greed — is very great.
13:41 — How Our Bodies and Environment Can Impact Our Choices
If you look at something as simple as being hungry or missing sleep, these things have a profound impact on the way that we make decisions.
There’s a famous study out of Israel that looks at the leniency or the severity of different judgments handed down by Israeli judges. Despite being some of the smartest people in one of the most technologically advanced countries in the world, it’s highly correlated with how recently they’ve had a snack.
If you ask these judges, why they gave one person five years and another person 25 years, they would undoubtedly cite some sort of historical precedent or some sort of jurisprudence, but the research shows that it’s like how recently they’ve had some almonds.
We do this in our own lives, too. We move through the world thinking we are in complete control, but unaware of how small things impact our decision-making. One example Daniel gives is about how liquor stores playing a different type of music dramatically influenced consumer choices.
The takeaway is that we need to be thoughtful with the way that we treat our bodies and the messages we surround ourselves with because they’re so impactful on the way we make choices.
17:00 – Why Are We Overconfident?
There’s all kinds of positive things that come out of overconfidence from a human or societal perspective, but it’s harmful in our financial lives because it causes us to think the same risks don’t apply to us that apply elsewhere.
There’s actually a couple of kinds of overconfidence. When most people think about overconfidence, they think of head-to-head comparisons like I’m a better driver than you. I’m better at X than this person.
Another form of overconfidence is that we think we are more prescient about the future than we actually are. We also think we’re luckier than we are. When you ask people to rate the likelihood of getting cancer or getting divorced. People systematically underrate the probability of these things really dramatically.
No one thinks they’re the one that’s going to get sick. No one thinks that they’re the one that’s going to get divorced. And so we don’t take care of our bodies, and we don’t do what we should in our marriages.
But yet if you ask people, how likely are you to win the lottery or to become a professional baseball player 100 other positive things, they dramatically overrate the odds of those things.
Overconfidence is everything from thinking we know more about the future than we actually do to thinking we’re better than the next person to thinking that we’re less prone to risk than other people. And I think it’s pretty easy to see how that confluence of things can make us really bad choices with our money.
20:58 — Using Mental Accounting Bias To Your Advantage
One of the most brilliant sorts of business applications of a deep understanding of loss aversion happened during the great financial crisis. Everyone was scared of losing their job or pay cuts, so big purchases really dried up.
Hyundai showed a deep understanding of excessive conservatism and loss aversion, by offering a full refund on a new car if you lose your job. By taking the worst-case scenario off the table, people were able to move forward. The result was that they sold four times as many cars as their next biggest competitor for a period of time during the financial crisis.
Financial professionals can take advantage of this framework of mental accounting. People tend to bucket their money. Even though the money is fungible — Daniel could use the same money to buy a Snickers bar as he could to apply towards a ticket to a Cardinals game — we don’t treat it that way.
Because we put these labels on different buckets of money, we tend to invest and spend and save it differently.
We can lean into this tendency by acknowledging that the average bear market is two years long and set aside two years worth of safe assets so that the investor is covered the next time markets fall. Like Hyundai, you take the worst-case scenario off the table.
On top of inoculating investors from the worst-case scenario, we educate them to help them overcome loss aversion and the poor choices that result from it. For example, the average intrayear drawdown is about 13.5%. And yet every time there’s a 10-15% dip in the market (like there is now), people act like it’s never happened before. But it happens as regularly as your birthday.
24:10 — Healthy Media Consumption
When Daniel worked as a clinical psychologist at an inpatient treatment center for women with eating disorders, the first thing they did was educate patients on proper media consumption.
Financial professionals should do the same. It’s important our clients understand that the media uses hysteria to sell newspapers and digital ads — they’re not reporting in a manner that’s for your benefit.
Daniel tells the story of being on a cable financial news network that as they were counting down, they told him: “Don’t be a nerd.” They wanted him to give them something good, not just a thoughtful, well-reasoned, evidenced-based take.
The most powerful thing we can do is be thoughtful about how we allocate our attention and make sure that we’re allocating that attention to the appropriate places.
28:39 — What Daniel Has Changed His Mind About In Recent Years
Daniel doesn’t feel joy in admitting that his belief in free will has eroded significantly. He feels like our buttons can get pressed more easily than we’d like. But this is a call to surround ourselves with the right people and put ourselves in the right places.
The more that we can be intentional about everything from the messages we put in our head to the things we put in our body to the people we surround ourselves with to the places we find ourselves — these are much better predictors of how your life turns out than your desire. We’re usually about as good or as bad as the things we put in our heads and the people we surround ourselves with.
But it’s less of a bummer when you realize there’s something you can do about it.
32:20 — What Does It Mean to Be a Long-Term Investor?
Being a long term investor is about putting first things first. That means living a life that focuses on what really matters, which includes all sorts of things besides investing and markets.
There’s this concept in behavioral psychology called substitution behavior. Instead of just trying to cold turkey behavior, we put something new in its place that’s more vivid and more worthwhile. From Daniel’s perspective, almost everyone spending time worrying about markets or their portfolio would be better spent learning a new hobby, increasing their professional skills, deepening their network, playing catch with their kid, or going to a baseball game.
Book Recommendations From Daniel
- The Geometry of Wealth, Brian Portnoy
- The Psychology of Money, Morgan Housel
- The Hour Between Dog and Wolf: How Risk Taking Transforms Us, Body and Mind, John Coates
- Warren Buffett Invests Like a Girl: And Why You Should, Too, The Motley Fool
- Man’s Search for Meaning, Viktor E. Frankl (Daniel says it’s the best book ever written)
Connect with Daniel
- Podcast: Standard Deviations
- Twitter: @DanielCrosby
- LinkedIn: Daniel Crosby, PhD
Resources
- The Laws of Wealth: Psychology and the secret to investing success, Daniel Crosby
- The Behavioral Investor, Daniel Crosby
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About the Podcast
Long-term investing made simple. Most people enter the markets without understanding how to grow their wealth over the long term or clearly hit their financial goals. The Long Term Investor shows you how to proactively minimize taxes, hedge against rising inflation, and ride the waves of volatility with confidence.
Hosted by the advisor, Chief Investment Officer of Plancorp, and author of “Making Money Simple,” Peter Lazaroff shares practical advice on how to make smart investment decisions your future self with thank you for. A go-to source for top media outlets like CNBC, the Wall Street Journal, and CNN Money, Peter unpacks the clear, strategic, and calculated approach he uses to decisively manage over 5.5 billion in investments for clients at Plancorp.
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