Animal Spirits Podcast - Talk Your Book: How to Make Better Financial Decisions with Daniel Crosby

Episode Date: June 5, 2020

On this Talk Your Book we chat with Daniel Crosby about behavioral psychology, why we're not wired to manage money, how to improve your financial decisions and how systems and automation can help. Find complete shownotes on our blogs... Ben Carlson’s A Wealth of Common Sense Michael Batnick’s The Irrelevant Investor Like us on Facebook And feel free to shoot us an email at [e-mail] with any feedback, questions, recommendations, or ideas for future topics of conversation. Learn more about your ad choices. Visit megaphone.fm/adchoices

Today's Animal Spirits Talk Your Book is brought to you by Brinker Capital. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Battenick and Ben Carlson as they talk about what they're reading, writing, and watching. Michael Battenick and Ben Carlson work for Ritt Holt's Wealth Management. All opinions expressed by Michael and Ben or any podcast guests are solely their own opinions and do not reflect the opinion of Ritt Holt's wealth management. This podcast is for informational purposes only and should not be relied upon for investment decisions. Clients of Rithold's wealth management may maintain positions in the securities

discussed in this podcast. Ben and I sat down for an excellent conversation with Dr. Daniel Crosby to talk about all things related to behavioral finance. During our talk, I mentioned my beef, for lack of a better word, with behavioral finance. And I want to be very clear, I think that learning about our own behavior, our own limitations, it's wonderful. And it often explains why we tend to make the same mistakes and predictable mistakes over and over again. However, what I was really driving at is that it's not necessarily the panacea that it is sometimes made out to be. Knowing our own limitations is just not enough to overcome them. So we talk about this idea, how to solve for it, and much more. Really hope you enjoy our

conversation and have a very nice weekend. We are joined today by Daniel Crosby, Chief Behavioral Officer at Bricker Capital. Daniel has a PhD in psychology and is the author of some excellent books such as the behavioral investor and the laws of wealth. Daniel sent thank you so much for coming on today. Yeah, great to be here. Thanks for having me. So not to get too much into background, but please, if you would, tell us how you got started in the field of behavioral finance. I started out to be a shrink. I went to start. school to be a normal psychologist. And about three years into my doctoral program, I discovered that I

hated it. So I loved thinking deeply about why people did the things that they did, but I knew that I didn't want to work in a clinical setting. And so I talked to my dad, who was sort of my biggest supporter, and he is a financial advisor. And he said, look, there's a lot of behavior. There's a lot of psychology in what I do, which thing I had sort of never supposed. I mean, I sort of thought of him at the time as a numbers guy, hadn't really thought about the psychological elements of it. But so after school, I pursued jobs in business. I got a job in a bank doing pre-employment assessment of bankers. So before they would hire a banker, I'd give them like an IQ test and a personality test to see if they were a sociopath, to see if they were smart enough. So I got

introduced to behavioral economics in the bank, sort of combined it with what my dad had told me those years ago and the rest is history. What do you think are some of the biggest takeaways you've gotten from both fields of psychology in terms of why is it so hard for us to make good financial decisions? Well, I think the reason it's so hard is that there's such a large knowing, doing gap. I mean, knowing what to do and doing the right thing have almost nothing in common, which is really sort of counterintuitive. Most people think that like, hey, if I read up and I figure out what I ought to do, then I'll just go execute. And knowing and doing have almost nothing in common. My favorite example of this was that in 1993, the U.S.

started labeling nutrition. So now every time we go to the store, we know exactly what we're putting in our bodies. Since that time, the U.S. as a nation has become twice as fat and three times as morbidly obese, even though we know exactly what we're getting now. So simple information isn't enough. So that's one big hurdle. You know, the other hurdle is the rules of investing are almost 180 from the rules of everyday life. And the laws of wealth, I called it Wall Street Bizarro world, where it's like, if you want more of something in most places, you do more things. If you want to get stronger, you lift more weights. If you want to get smarter, you read more books. And then in the market, if you want to get bigger returns, you basically do nothing.

So many of the rules of being a successful investor are sort of paradoxical or counterintuitive. So those two things, I think, combined to make it a very difficult thing to master. So let me ask you this. People have said oftentimes that one of the biggest problems is a lack of education. We're not taught about financial matters, really at all, not in grade school, not in high school. Do you think that that would have any influence? So it's necessary, but not sufficient. I think it's a good place to start because one form of knowledge is meta knowledge,

which is effectively knowing what you don't know. So I think a lot of what financial education is good for, sort of, again, counterintuitively, is just helping you know enough to understand the deficits in your knowledge and know when to bring in an expert, know that you can't do it by yourself. For instance, I learned biology and I remember literally nothing about biology. Now, again, I guess my future retirement doesn't depend on me knowing anything about biology. so maybe it's not a great comparison. But I agree that that is probably necessary but not good enough because it's not an education thing. For example, I know how to get a six-pack, work out, eat well,

but lo and behold, I have a dad-butt. I don't have a six-pack. So do you think that this is more of a cognitive development thing than is an education thing? Yeah, I think you really need three things. And they all start with E because all great truth either rhymes or is illiterative, as we all know. So I think you need education sort of as the first step. I think you need the right environment, which is the right portfolio, basically a portfolio you can live with. And then you need encouragement, which is a financial advisor or a coach or someone to sort of slap the bad decision out of you at the moment of imprudence, right, at the moment

when you're about to do something wrong. So, yeah, I mean, to your example, and people hate this. I hate that I even have to burst this bubble. But education is just a really weak predictor of making. many things. So I don't think it's useless. I would love to see more programs in schools, but it's really just one leg of the stool. So how well equipped do you think those coaches are, those advisors are at handling their own behavior? Because a lot of times what happens is clients look to them as the expert and assume, well, this person is very smart. They must

know what they're talking about. They've studied a lot on this. How well equipped is that group of advisors, which were a part of basically to handle that? So the research on advisors is interesting, and again, sort of points to the thornyness of behavior. So the research on advisors says that they are excellent at working with their clients as a group. People who work with financial professionals dramatically outperform that those who don't as a group. Research shows most of that owes to behavioral alpha sort of improvements in financial decision making. But then when it comes to advisors' own portfolios, advisors tend to make the same mistakes in their own portfolios that anyone else makes. So I mean, I think one of the questions I would have for an

advisor is, do you work with an advisor? Because I think a good advisor is going to understand that the value out of an advisor is primarily behavioral and will seek that out for themselves. So that would be sort of a vetting question for me if I were seeking out an advisor. One of the biggest things that you talk about all the time is behavioral coaching. How do financial advisors become behavioral coaches themselves? Yeah. So there's a couple of things. So, Kitsis and Carl Richards had this conversation recently about how do you become a behavioral coach because nobody wants you to come to them and say, wow, look, you're so flawed, you're so broken, let me help you with this. I think there's elements of behavior that are woven into very everyday

practices. A comprehensive financial plan is behavioral if you think about it in the right way. Something like goals-based investing, just talking to this client about keeping their goals front and center has strong behavioral outcomes associated with it. Even something like ESG, like I'm a little bit of a cynic about ESG from a change the world perspective, but I'm very high on ESG from a behavioral perspective because I think that people who are investing in a way that's aligned with their values, the evidence shows that they're more likely to stick with their plan. So even something like ESG, which seems sort of peripheral to behavior, is really pretty central to it. So I think one of the ways that we need to do it is realize that a lot of what we're doing is already

behavioral. I'm among the voices that says, look, when I have young kids, I hope when my kids go to college, behavioral finance is no longer a standalone discipline because I hope that it's so integrated into the broader world of finance and financial planning. So I think we're already doing a lot of things correctly. A second thing would just be a deep, sort of brutal examination of your own biases and shortcomings. And then the third thing I would suggest, I would be just automating everything. If there's one big takeaway from the behavioral finance literature, it's that no amount of education, no amount of self-awareness can take the place of automation. So I think that automating processes left and right is a really powerful behavioral tool as well.

When you spend your time with people, are you talking more to the advisors or the end clients on this stuff? It's probably 90% advisors. 10% clients. I do a bit of both, but it's very advisor facing for sure. And how are advisors typically trying to hide the fact that, because there's one step we saw that like over 80% of financial professionals said behavioral coaching is one of the most important things they do, but then like 6% of clients said the same thing. So obviously they're either not marketing that as a piece of what they do or they're hiding it in some way. Is there a way that you can do that without beating the client's head over with it? Yeah, I think one of the things that,

we can do is we just have to tell the new story. This is from a Natixis study from a couple years back that you're right. It was 83% of advisors said it was the biggest value add, 6% of clients. Clients just don't even know that it exists. And for so long, they've been marketed performance. They've been marketed performance. And so can we blame them when they are looking for performance? We've marketed that to them for a very long time. The other thing I think that advisors have to do is I think advisors who ostensibly love behavioral finance want to compete on performance when it's convenient for them. They'll have a good couple of years and go, yeah, look at me, you know, look, we had a good couple of years. How about that? Like, I'm really

killing it and not giving appropriate circumspection, not giving appropriate nod to luck and things like that. So I think we need to start to tell a new story. I think we need to start to share the research with them. We need to start to be more holistic. I don't even think we have to label it. Open up. Here comes some behavioral coaching. But I think when people feel the difference between someone who has a behavior first approach and someone who is more transactional, I think it'll just feel different. So yeah, telling a new story, having an experience-based economy, if you will, and then not falling back into bad habits when it's convenient for us or it supports the narrative of the moment. So a two-part question. First, do you think that one of the reasons why there's such a giant

gap between advisors perceived value ad and clients is that people don't want to talk to an advisor and be spoken down to? They don't want to be told that they can't control their emotions. What do you make of that? And then secondly, what does it mean, maybe this is a bigger question, what does it mean to be a well-behaved investors? Does that mean buy an index fund to never, ever, ever do anything? Yeah, yeah. To your first question, I wrote an article on this recent. And I think one of the things we have to avoid is speaking down to people. It's human nature. We grasp intuitively that one of the things that people look for when they're looking for an expert is this sort of authority. So we can fall back on jargon. We can fall back on being pretentious. We can fall back on big words and chalk striped suits and these sorts of things. But that's really, really off putting to people. So I think people want you to be knowledgeable, but they want it in an approachable way. That's why I think why, platforms like your platform, the platform that I'm trying to develop in many others that we see on social media and throughout Fintwit are sort of a kind or gentler way of proving authority.

You're trying to add value. You're trying to educate, but you're not pompous about it. So I think that that's important. Being a well-behaved investor is going to look somewhat different for different people. I mean, I think there are some hallmarks to it. There's the hallmarks of multi-asset class diversification, which is lived humility. I mean, that's a lot of. That's sort of the embodiment of saying, you know, I don't know what the future holds. I think there's a hallmark of a high degree of automation or at the very least some sort of systematization or checklists. So I think some of those things are in common. But I think it's going to look different based on people's capacity for risk, their composure towards risk, which is sort of the

fancy word for saying how likely they are to be bumped off course. Someone like me, I keep a small percentage of my assets in sort of a be stupid fund. I keep two to three percent in sort of a day trading, be stupid with this money fund. And I know that I'm being stupid. And it's sort of the equivalent of a cheat day. You do it 97% right. You know that your impulse to want to play the market actively is there. So you give voice to that impulse in a limited way. So that's not strictly speaking all that well behaved, but it's a preventative measure and not letting perfect be the enemy of good. Ballparking it, what percentage of investors out there need some sort of behavior of release

valve like that? It could be a fun portfolio. It could be you put 5% of your money in Bitcoin or time market wherever you do and you don't have it automated. How many investors would you say that just from your experience actually really need something like that and don't have the ability to just be a robot? So Morgan Housel has this stat that he admits he totally made up, but it's also completely consistent with my living experience. So this is my confirmation bias and respecting Morgan a lot. But he says effectively 10% of people are degenerate gamblers, right? Like 10% of people, there's no helping.

10% of people are enormously disciplined and really don't need an advisor and can just do this thing all by themselves. And then for the 80% of us in the middle, we're going to need some sort of behavioral intervention, be it this sort of tiny slush funder, or whatever it may be. When I first heard him say that, it was wholly resonant with my own experience. So I'm going to, I'm going to keep promulgating this fake news and saying 80%. Has there been anything that stands out or that really surprised you about how certain investors

have behaved during the most recent episode of market volatility? Yes. So I have been surprised at just how sensible people have been. It's a little scary for my job security candidly. When you look at the research around what retail investors have done, they have by and large been very, very well behaved. And even those who have tried to time the market, you look at the inflows into Robin Hood and things like that. Some of these folks have actually timed the market quite successfully. I think if there's anything surprising about the behavior of retail investors in this most recent panic, it's how little they have panicked. And I think you're seeing some of the hard work of advisors. I think you're seeing some of the hard work of

financial educators paying off. And people really have stayed the course. I think it was also just so fast. I think in some ways it just happened so fast that people didn't have time to make poor decisions. I've posed this question to Michael before. He's skeptical. I think it's possible. Do you think that a lot of this work of the last 20 or 30 years of behavioral finance is working in that investors are on the margin becoming better behaved because I think it's possible. I don't buy that for a second. Yeah. So I tend not to think that human behavior changes very much. I candidly don't know quite how to account for the good stuff I'm seeing because I think one of the things that's so interesting about studying human behavior is that it's in a big way pretty immutable. Not much

changes from generation to generation. As I mentioned earlier, even stuff like education is usually fairly impotent against strong emotion. So don't know quite how to account for it. I'm hopeful that behavior is changing. I will remain skeptical until this persists. I have another potential theory is that because the rapid decline in the market was due to the coronavirus lockdown and the economic impacts, I think it almost put money in perspective. People realized how unfortunate so many people are and people with money, people, you know, our clients said, you know what, it's only money. Not its only money, but you know what I mean. And the market will come back over time and they're more important things to worry about right now. I think that if we had a 35% decline in 20 days

or whatever it was because of economic impacts, I think the behavior would be a lot different. It's interesting to think about who was impacted by COVID-19 as well. It's far reaching to be sure. but people who made less than $50,000 who owned little or no equity were disproportionately impacted by coronavirus. And so I think by and large, the stockholding class has been somewhat insulated from the impacts of coronavirus at this point that may or may not continue to be the case. But I think that many people, many investors have been largely unimpacted by this. it's a little scary to me because I think that it's going to heighten inequality in our country. I think there's some really, really bad stuff to come out of this economically and otherwise. But yeah, I think the stockholding class by and large has had this much easier than the rest of

the country. And you see that reflected in the market. So the first behavioral finance book that I ever read was predictably irrational by Dan Ariely. and I felt like somebody had shown me the light when I read that book. I recognized so many of the foibles in my own behavior because at that point, I was pretty much day trading without admitting it to myself. And I just felt like sort of the map. You didn't think that buying three times levered bank ETFs was day trading? Stay out of this.

And then like your money and your brain and thinking fast and slow and all of these books that are really in the pantheon of behavior finance, do you think that learning a little little bit about behavioral finance can actually be quite dangerous because instead of coming to the conclusion that, oh, wow, we will always be blind to our blind spots. Instead, we think we've got it all figured out. I think that it's possible that learning a little bit about behavioral finance can actually have adverse consequences. My observation is that people who have a little knowledge of behavioral finance typically use that knowledge to point fingers at other people. So that's been to make post hoc explanations of what happened and to point fingers at other people.

And I think it was Jason Zweig who wrote this piece about using behavioral finance as a mirror and not a window. The point of behavioral finance is a mirror into our own behavior and not sort of a window through which we peer down at the unwashed masses of humanity making dumb decisions. So I try to tell people, when you read my books, read it with an eye to changing your life. and being a better person, the one big takeaway for me from grad school, because let's face it, I don't do much with my clinical psychology background, really, my one big takeaway from grad school was having to sit through hundreds and hundreds of hours of my supervisors and my peers watching tape of me doing therapy and criticizing that work. The same way that an athlete watches tape, my peers would watch a session I did with a client and go, why did you say that? What were you trying to do there?

And at first, I was really, really defensive about it, but I learned over time to sort of take that criticism to grow from it. And so learning that skill has been invaluable, even if a lot of the other stuff I learned I don't use every day. And so I totally agree that a little knowledge of behavioral finance can be dangerous. I tend to think that a lot of the behavioral finance experts, maybe I'm off here, but people like Conneman is almost pessimistic. And I almost think that it's kind of like comedians, like the best comedians are just miserable. in their life and then that misery comes on stage and it makes people laugh. Do you think there's something to that, the fact that Connman says, like, even he can't change his own behavior?

85% of behavioral finance experts come from a broken family. Yeah, I'm just saying maybe it's just studying all these human foibles for so long, it makes it so much harder. And if you're not in that clinical setting where you're one-on-one with someone, it's much harder to change that behavior than it is just putting it out to the masses. Is there something to that where it's even hard for the experts to change what they do. Are you asking me if I'm miserable? Is that what? If you're asking me if I'm miserable, I definitely am. I'm from a lovely home. No, I think you're exactly right. I mean, you listen to Connman or Thaler, any of these people, when people ask Thaler, how should I approach the market? He goes, diversify and go watch football. Conneman says, basically, I've won a Nobel Prize for

this work and I'm no better for it. But for me, the big takeaway, I entered into the field of behavioral finance with an eye to saying, how can we exploit these behavioral irrationalities to generate alpha? Coming out the other side of that, I basically walked away by saying, well, it's extremely tough and I'm not sure it's worth it. So I think when you really learn enough that you become really, really, really humble. I started my PhD program when I was 23, really, like, sure that I was going to have humanity worked out by the time that I got done. And by the time I got my doctoral degree, I felt less capable than when I started because humanity had thrown me a lot of curveballs by that point. So I think there's a lot of truth to that.

One beef that I have, for lack of a better word, with behavioral finance, is that it's mostly diagnostic, but not very prescriptive. So, okay, we get it. We make the same predictable mistakes over and over and over, but now what? And maybe now is a good time to talk about an idea that you came up with, Tulip, which is a behavioral finance software platform. So talk about what I just brought up and maybe how does Tulip help? Yeah. So if you think about it, I mean, that's the knock on psychology general and that's been sort of the holy grail of psychology. We talk a lot in psychology about physics envy. We want to be able to predict human behavior with the same sort of precision with which you can predict this speed that a wheel rolls downhill or something like that.

Frankly, there's a degree to which that's just impossible. We're even glad that that's impossible because it gives rise to sort of the idiosyncrasies and quirks that make us all fun to be around and fun to study. But so Tulips, a behavioral finance software that we've been developing at Brinker, we did this in response to a financial planning.com survey that found that two years in a row, they ask advisors two questions. They said, what do you think? think is the fintech of the future and what fintech are you currently using vanguard yeah right and two years in a row people said the fintech of the future is behavioral finance tech and two years in a row nobody said they were using any behavioral finance tech so it's not often that the market that

gives you that kind of opening and so yeah we developed this thing it's basically got three parts to it it measures human behavior in three different ways first is it just asks you some questions about your behavior, so nothing new there. There's a bit of self-report to it. Next, it has a gamified simulation of 30 years of market history. So you sort of get to experience a little bit of market history. We have real ups and downs. We have real news reports. And the person makes decisions about their portfolio in real time. And then third, it looks at your, effectively your history, your trading history, your history of behavior. Then we give information to the advisor about who that person is, how they're likely to behave, and we even alert them in real time

when that person is at risk of making an error, when we run across information that is similar. If we find that Michael Batnik, every time he loses a round number, every time Michael Battenick goes from a million dollars to $900,000, he freaks out and does something stupid. I wish. I definitely could have used this 10 years ago. Right. It's a little bit too late from me. Yeah, so we're able to alert the advisor. So it's got all the legs of the stool I talked about before. We educate people about their behavioral tendencies. We're able to recommend a portfolio that's going to help them stay on the ride. And then we also give real-time alerts to their

advisor when they're at risk of doing something problematic. So this syncs up with everything, every other tool that an advisor is already using. It uploads all the statements. All the numbers are there and it just offers them sort of checkpoints along the way that they can help their clients with as well. Is that the idea? Yeah, that's right. That's right. And it even monitors market conditions in real time. So, again, we find that we'll just use Batnik again. We find that Batnik, anytime there's X amount of volatility, Batnik wants to do X, Y, Z, dumb thing.

We ping the advisor a little bit before that and say, hey, your boys on the ledge here, you may want to give him a call. That's like a minority report. Yeah, it's pre-crime, right? Pre-crime for behavioral finance, yeah. When you were developing this tool, was there anything that you left on the cutting room floor that you said after running through some different variations and experiments that you thought, okay, we thought

this was a good idea. It actually doesn't really help at all. Is there anything there that you tried to do that you didn't end up leading in here? So we initially set up, I mean, there's a hierarchy. You know, I talked about the three different things we measured. We initially set out to make this behavior only. Don't ask people anything. I'm not going to ask you what you like, what you don't like. I'm just going to observe your behavior. And we found that because the behavior is so constrained by an advisor. A lot of time someone's trading history will look rather clean, but what you're not seeing is what you see in the CRM data or something. You don't see their Robin Hood account. They've been blowing, yeah, right. Either it's happening offline or they've been

blowing up the advisor. And so we found in an ideal world, observing someone's behavior is the best predictor of future behavior. Past behavior is the best predictor of future behavior. But there's so many sort of intermediations there that it wasn't great. So we needed a little of everything. Is it also like a financial planning software as well? It would be an augment to a financial planning software. And is this currently for advisors only? Yeah, it's for advisors only. I think it has application to retail clients and to self-directed investors down the road. That's certainly somewhere I'd love to take it because, you know, I think at least on paper, if we could nudge people in the right direction help make them more aware of their behavioral tendencies, you might see people

DIY with more success. So that's the theory. I think we'd love to take it there eventually, not there yet. This was in place during the most recent bare market, obviously. I think you actually introduced this at Wealthstack in September. Was that the first time that you really put it out there? And now it's been working since then? We introduced an MVP at Wealthstack. So since that time, we've been using it in a super limited beta. It's been very small. So unfortunately, it wasn't available for public consumption in the most recent downturn, even though we were using it internally and sort of norming it internally during that time. So yes, my timing would have been impeccable if it had been around. Unfortunately, it was not. Thank you so much to Daniel Crosby for

coming on. Thank you, Bricker Capital for sponsoring the show. This is excellent. Thank you, Daniel. Yeah, my pleasure. Thanks again to Daniel and Bricker Capital. For feedback, Animal Spiritspot at gmail.com. Thank you for listening and we will see you on Wednesday. Thank you.