Bob Seawright, author of The Better Letter, joins to share insights on making behavioral finance actionable.
Listen now and learn:
- How to make behavioral finance actionable
- The two human biases that matter most
- Why it’s important to focus on process rather than outcomes
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Show Notes
Bob Seawright is the Chief Investment Officer for Madison Avenue Securities. For over a decade, he wrote a blog titled Above the Market before transitioning in 2020 to The Better Letter.
Bob is well known among the financial blogosphere for his powerful insights into human behavior and unique perspective on world events.
Throughout the year, Bob has published a series of pieces on making behavioral finance actionable. Behavioral finance has generated a lot of fascinating insights, but it hasn’t had much practical impact on financial advisors and their clients seeking to make better financial decisions.
Here are my notes from our conversation…
More to Money Than Financial Returns (0:45)
When we recorded, Bob had just gotten back from his summer cottage, which he wrote a full chapter about in this book. For as long as I’ve known Bob, he has called his summer cabin “a terrible financial investment,” while also referring to it as the best family investment he has ever made.
Stories like these are an important reminder that life isn’t purely about optimizing dollars and cents. It’s becoming cliché to say that money is just a tool to help you live the life you want – but it’s true.
Making Behavioral Finance Actionable (4:05)
Bob once asked Nobel Laureate Daniel Kahneman: “What’s the best way to combat all of the behavioral nonsense we’re all subjected to.” To which Kahneman chuckled and said, “not much.” Kahneman also suggested one find their smartest, least empathetic friends and have them tear apart your ideas.
Almost everyone in the financial profession finds behavioral finance interesting, but we all still struggle to make it practical.
Bob gives one example of practically applying behavioral finance insights from his own life. The research shows that the more you look at your investment statements, the more you trade. And the more you trade, the worse you perform. So Bob doesn’t have online access to his accounts and he only looks at his paper statements twice a year.
I’ve done something similar with my own investments. Outside of my 401(k), I only own a single fund (See: How I Invest My Money) and I only really check my statement once a year when filling out a net worth statement. Both are activities to minimize my urges to trade or do anything other than stay the course.
The Different Ways of Consuming Information (9:41)
The internet has shrunk the world. In our pocket, we carry basically everything humans have discovered, figured out, or thought in all of human history. That’s fantastic in many ways, but it’s also a problem.
There’s a long list of biases we humans all have, but Bob calls out two that matter most: confirmation bias (we see what we want to see) and bias blindness (we see other’s biases, but not our own). The internet makes it very easy to fall prey to these problems. Once you hold a belief, you might Google it and find the first thing that tells us we’re right.
If we read something that agrees with us, we ask: Can that be true? And we can almost always find a reason why it is.
If we disagree with it, our internal thought process: Must that be true? And we can almost always find a way that it doesn’t have to be true.
Those two different standards are always at work in our brains. The internet makes it really easy for us to find what we want to find.
This makes me think about when I listen to a podcast during my commute or I’m reading a news story after the kids have gone to bed. In these situations, I’m just trying to relax and it’s easier to look for information that I agree with. I’d like to think it’s a little different when I’m consuming information for work, but I share this because I think most people are consuming information as a form of relaxation or hobby.
Our brains are efficiency machines. Due to evolution, our brains seek to be as lazy as possible since they take up a lot of energy. Sorting, prioritizing, and interpreting all the information that’s out there is a lot of work. And we’re working with hardware that was designed hundreds of thousands of years ago, which makes the task of thinking scientifically as we consume information more daunting.
The Difference Between Deductive and Inductive Thinking (12:20)
We want things to be deductive. We want 2 + 2 = 4. We want certain, clear, unequivocal, non-probabilistic answers. But that only works in a closed system. It works in math, because math is the closed system.
The world is inductive, meaning that we can only make tentative conclusions based on the information and the evidence that are before us. No matter how sure we are that we’re right, if we find better or different evidence, we may have to rethink anything and everything.
That means we hold our positions probabilistically. Humans are terrible at that. We don’t like uncertainty, ever.
Nassim Taleb has the best example of inductive reasoning. You can see a million swans that are all white, and so we can conclude that all swans are white. But if you go to Australia and see one black swans, you have blown up your hypothesis despite having seen a million white swans. That’s inductive reasoning and that’s really hard for us humans to do.
The Importance of Focusing on Process Over Outcome (13:50)
Focusing on the process rather than the outcome is incredibly important when making investment decisions.
Annie Duke talks about “resulting” in poker where you play the hand perfectly and you still lose. Bob uses baseball as an example where you do everything right as a hitter – you see the pitch and crush a line drive, but it goes directly to a field for an out. On the flip side, you might get fooled by a pitch and bloop a ball to the opposite field for a hit.
Life is like that. Sometimes you make stupid decisions that turn out great and sometimes you make great decisions that turn out poorly. There’s a lot of randomness built into the world.
That brings us back to inductive versus deductive. If your process is right, you increase your odds. There are no guarantees, but it gives you the best chance. And that’s all we can do.
Bob jokes that clients hate that and would prefer to know that if they do it right that they will have a good outcome. There are lots of people out there that promise that in order to get sales, but it’s simply not something that can be certain.
Solving for Human Behavior (17:20)
Anytime I’m trying to put what is happening in the world into the context of what actually matters to a client, my primary motivation is to make sure they avoid mistakes.
A quote from Bob’s work on empowered teams that I really liked:
“The best check on bad decision making is when we have someone that we respect, systematically set out to show us where and how we’re wrong.”
When you hire an advisor, they’re obviously supposed to take care of the nuts and bolts of execution. But they also should be there to reject the ideas and help sort/interpret/prioritize all that information out there.
Outside input and accountability are two components that Bob identifies as a means for helping reduce behavioral errors with our finance.
But he also notes that it’s important to support clients when they do something that is less than perfectly efficient if they have a good reason for it. He shares the story of prioritizing his children’s college education over his own retirement – a choice his wife and he made based on their values and personal experiences.
Another example that comes to mind is the choice to pre-pay a mortgage, which is rarely mathematically optimal. As an advisor, it’s important to create an environment to discuss the potential consequences of not doing the most efficient thing with your finances, but not to beat them up over it.
And I think this is a really big benefit of when you get that outside unbiased help. Yes, it helps reduce these behavioral biases, but also gives you a chance to feel more empowered, when you do stray in a direction that is meaningful to you.
How to Make Fewer Decisions (22:25)
The fewer decisions you must make, the less likely you will make a mistake.
Automation is obviously a great way to make fewer decisions. Automate your savings, investing, bill paying, etc.
Building good habits is another. There are lots of examples of good financial habits. Bob suggests simply waiting a day to check out when you fill your cart on Amazon with items that total to more than $100. It’s a small habit, but it makes a big difference in slowing us down and avoiding unnecessary spending.
He also talks about addition by subtraction. He mentions some new research that says we intuitively look additively rather than subtractive. If we see a problem, our mind immediately goes to the things we can add to solve it when we ought to instead maybe think first about things we could subtract to solve the problem.
It’s not to say that subtraction is inherently better than adding. But thinking about dealing with problems in terms of subtracting something as well can help you get the right result.
Checklists also reduce the number of decisions you need to make. The Checklist Manifesto is the essential resource on this idea. Bob explains two examples from the book on airplane maintenance and hospital surgeries – in both cases simple checklists led to fewer errors and more consistent outcomes.
Bob also talks about a future piece he is working on that addresses the challenge of aggregating information with a sufficiently broad range of opinions while also eliminating the noise (or as he says “keep the truly crazy stuff out of your inbox.”).
We’re all susceptible to crazy stuff. But we’re also susceptible to responding to the crazy stuff. Something that can really help is having trusted experts. Having a trusted expert helps relieve stress, but it is also a way to avoid needing to make more decisions.
In a world where the total amount of information doubles every couple of years, having people in positions of authority to give us advice can make it easier to better consume information and make decisions.
Resources
- Above the Market by Bob Seawright
- The Better Letter by Bob Seawright
- How I Invest My Money: Finance experts reveal how they save, spend, and invest
- Episode 2: How I Invest My Money
- The Black Swan: Second Edition by Nassim Taleb
- The Checklist Manifesto
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