Animal Spirits Podcast - Talk Your Book: The Madness of crowds

Episode Date: February 12, 2021

On today's show, the guys talk to Daniel Crosby, PhD, the Chief Behavioral Officer of Orion Advisor Solutions about some of the craziest few weeks in stock market history.    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 is brought to you by Ryan Advisors. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnik 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 Ritthold's wealth management may maintain positions in the securities discussed in this podcast.

Today, we're joined by Daniel Krosby. He is the chief behavioral officer at Orion Advisors. Daniel is also the author of two of my favorite books, The Loss of Wealth and the Behavioral Investor. Man, we're happy to have you on. What a great, perfect time for you to be here. Perfect timing. Great to see you both. The last two weeks, has this been the most exciting time for you as a market observer? have been in absolute heaven. I mean, it's been so much fun for me. I was running on like two and a half hours of sleep per night because I was just up every night just in the darkest corners of the internet trying to figure out what folks were going to do next. It was so much fun. I've had

to step back from it a bit. I was enjoying myself too much. What is your big takeaway from all this so far? What is the thing that stuck out to you most? Maybe the thing that stuck out for me most is that there's no narrative so pure that it can't be co-opted by bad actors. Whenever you think the market's going to do one thing and there's one set of motivations behind it, sure enough, the profit motive will emerge and the smartest people will still be the smartest people and the big guys are going to end up on top at the end of the day. Looking at you, Jerome Powell. One of the things that we want to talk about today is just the access to

maybe making some not so good decisions. Let's talk about how we got here and what does this mean for all of us going forward. I have started saying in the last two or three weeks that I think that the investors of today are more primed for bad behavior than any investors at any time in market history previously. When we think about what constitutes someone's experience of the market, the two big drivers are the psychological phenomena of primacy and recency. Our image of a phenomenon is greatly shaped by our early interactions with that thing and our late interactions with that thing. Now, if you think about market participants today,

whether you've been investing for one year, 10 years, 20 years, your formative entry point into the markets was something crazy. It was the dot-com bubble. It was the great financial crisis. it was the corona crisis and the ensuing fear and then greed, almost everyone, even if you've only been investing for like 20 years like me, you have ridden out some of the craziest markets in history. So I think most people's early experiences of markets were strange and their recent experiences of markets are strange. So I think we're dealing with an investing populace right now

that has a very volatile mindset with respect to the markets. And so I think there's a lot of opportunity for misbehavior. Do you think it's possible that we have, even though it's such a big part of our lives now, have we underrated the importance of the internet? Is this stuff just all going to be amplified going forward? And is craziness just part of the markets now, like, in a way that it's never been before because things are just happening so much faster? It's funny to say that something as ubiquitous and pervasive as the internet could get

inadequate coverage. And yet I think that's what we saw. I think that's what we saw with the Wall Street Betz phenomenon. Who could have guessed that Reddit, which has been around forever? And Wall Street Betts, which has been even around for some time, could have driven something like this. I think the ease with which we transact, the fluidity and the quickness with which we receive information, I think it's just going to make markets more volatile for the foreseeable future. I just think that's the new normal for us, if you will. So Daniel, I forgot to mention the accident. You actually know what you're talking about. You're not just making shit up. You got your PhD and what exactly? Psychology. I have a PhD in clinical psychology. I actually trained to be

a shrink. Okay. So let's dig into this angle for a bit. When people say, I've seen this movie before and I know how it ends, what exactly is happening inside of their brain? Are they lying to themselves? Do they really believe it? Like, what's going on there? because we've seen prequels, I guess, and different versions of this genre, but we don't know how this ends. I think you know how it ends in the long term, but even in the short to medium term, no one knows how it is. That's all that matters for a lot of these folks. Markets really can remain irrational longer than we can remain solvent. And if you look at people who've been screaming about overvaluation in the market and I know how this ends and this doesn't end well, I mean, that's been going on for. for 10 or 11 years now.

That's the kind of thing. You can't be wrong for a decade. I think that in the face of all this craziness that we're talking about, it becomes more important forever for people to sort of double down on humility, to double down on diversification, on the benefits of working with a professional. I think all of this stuff, in the face of this sort of craziness, the winners are going to be the people who just do the blocking and tackling again, because no one knows how this is going to end, at least on any kind of reasonable

timeline. I think that's a great point because you hear these people say, like, of course, human nature is the one constant in the markets. And I totally agree with that. Behavior is the one thing that we can actually manage in our own and maybe seeing others. But so many of the behaviors we've seen in last year are so counterintuitive. If human nature is this constant, why does it remain so hard for people to just anticipate the reaction of others when we have a time of crises like this? I think behavioral finance has more. post hoc explanatory power than it does predictive power. So that's where I think people sort of get it twisted. I was giving a presentation recently about the market forecast from last year,

January of 2020, what were people's forecasts for the year? Every single one of the big banks, every one of the big sort of white shoe Wall Street firms undershot the performance of the market dramatically. Now, if you had told those people in January that, oh, yeah, there will be a pandemic as well, a global pandemic and the entire economy will be shut down, they would have missed the mark by twice as much as they did. I don't believe anyone who would sit there and say to your face that if you had told them in January what was going to happen, they would have got this right. I do think that there's this sort of misapplication of behavioral finance that ends up being sort of a sophisticated form of hindsight bias, because I think when you really,

really get down to it, the only thing that we can know is that we can control our behavior in the here and now. And I think you become a very boring investor when you're truly as humble as you ought to be about how human irrationality can move markets. Let's talk about some of the behavior that we're seeing with the herd inside Wall Street Betts, how does behavior differ from individuals to groups? And I feel like one of the first moments I had realizing that people act very differently in group versus individuals at Temple, for example. The rabbi makes a joke that nobody would ever laugh at if it's one-on-one, because it's just objectively not funny. But when you got 400 people in a room, it's like an uproarious

laughter, like he's Richard Pryor. So let's talk about this. And I think that group behavior, the actions of the herd are amplified right now for a very specific reason. I'm here in Atlanta. I just read an article that said that calls to the mental health crisis line in Atlanta are up 450% year over year. That's happening all over the country. So when you look at the predictors of mental wellness, number one predictor of mental wellness is relationships. If you're looking for what makes people happy. It's close-knit relationships. And we have been starved of that for going on a year now. So what you see people doing in an unprecedented way is looking for connection, looking for a relationship in the places where they can get it. And that's why I think

these investing packs, Wall Street bets, Reddit penny stocks, stock twits, and some of these others, these are communities where people can connect in real and powerful ways at a time when they've been starve for connection. So that's sort of the gasoline on the fire of group behavior. But when we talk about group behavior, group behavior is one of the things that has kept us alive for hundreds of thousands of years. That's one of the things that we did better than every other humanoid species was with that we cooperate. So that cooperation tends us to do less due diligence, to think less, rely on the opinions of other people. We've got this unprecedented time of relationship starvation and you pour that gas on the fire of group behavior and the way that thinking as a pack

makes us less scrutinous of a decision. And you see what we've seen over the last weeks and months. One of the hardest things to wrap your head around was the fact that these people were saying, I don't care if I lose money on games, not because I'm doing this as a group and I'm doing this for another reason than making money, which you're seeing these actions by market participants that almost are detached from market reality. And we have so much sentiment in group hurting driving markets that it's got to be almost impossible to be a fundamental analyst in this type of environment, right? Because of that hurting. I've joked about wanting every minute of my life back that I've ever spent reading a book on fundamental analysis, but just seems so disconnected

from the way things are. For the past two weeks, and I know you guys are the same, I've had buddies from college texting me who don't know a stock from a hole in the ground talking about diamond hands and tendies and sticking it to the man and really, really buying into this narrative and really wanting to be a part of this thing that felt like an organic uprising. And this is, again, at a time when people are sad and people are lonely and they're looking for something, I think any time you can pair these two things, people want two things. They want to do good and they want to do well. They want to be part of something bigger than themselves. They want to do good in the world and they want to make money. When you can pair doing good and doing well,

think about Tesla. Part of the reason that Tesla is such a cult stock is because you pair this halo effect of doing good for the environment with being able to show people that you can afford a $70,000 car. It's doing good and doing well. One of the reasons that Wall Street's bets took off because it promised riches. No one should underestimate that as being a primary driving motive of this whole thing. But it was the promise of riches with the promise of sticking it to capital T, capital M, the man. And that's a powerful, powerful motivator for a group. Can we talk about getting rich quick versus getting rich slower. Whatever rich means to you, whatever the number is, it's not relevant. But the idea of getting rich quick is so seductive because it's like

the ultimate dopamine hit where your life could change, you know, in a matter of weeks, literally, like in some cases with these stocks, with these options. Whereas building wealth over time is slow and boring and can almost in a weird way not feel good because you adjust your lifestyle very slowly over time, that before you know it, if you've done well over a 15-year career, you went from making $40,000 to $175,000, but it happened so gradually that you didn't really get to experience any sort of adrenaline. It was just you make more money, you spend more money. You wake up and you're making more money than every thought you would, but it happens so slowly that you couldn't enjoy it almost in a weird way you could get out over your skis

with the hedonic treadmill. Maybe talk about the mental difference between getting rich quick can get over slow. The psychological variable we want to talk about here is something called salience. And salience has to do with how easily you can imagine something, how vivid a memory or an imagination of something. Shark attacks kill way fewer people than something like diabetes, but people are more scared of shark attacks than diabetes because the image of getting, you know, torn to shreds by jaws is more vivid than you eating too much sugar over 30 years and then having health problems in old age. The same thing with get rich quick versus get rich slow. If I say, here's how you're going to get rich. You're going to work an entry level job and then you're

going to work hard. You're going to make a little more. You'll save three grand your first year and the market will turn that into $3,100. The process of imagining that is quite boring and quite dull and it's not at all vivid. The process of you putting 10 grand on a triple zero penny stock and having Reddit take it to five cents or whatever is a totally different ballgame. The picture of you hitting it rich on some out-of-the-money call options and buying a Lambo the next week was a very different level of salience than getting rich slowly. And so that's the thing we need to remember. But you talked about my book, The Laws of Wealth. One of the chapters is called getting rich quick and getting poor quick are sides of the same coin. And that really is the case. Your portfolio can

shoot up 50% in a day. It can drop 50% in a day. And people need to understand that those are sides of the same conversation. And in your book, the behavioral investor, you devote an entire chapter to ego specifically. I mean, for most investors, that has to be the biggest behavioral issue right now, right? That their ego is getting too big and they think they're a genius and they think everything they touch turns to gold. There have been some people out there in Fin twit and other places saying, no matter the outcome of the GameStop thing, at least people are getting exposure to markets. I sort of take issue with that. And the reason I take issue with it is because no one is learning the right lessons. People are either learning that you're going to lose your shirt in the first

week or that you're going to make 200 percent returns in the first week. No one is learning an accurate, longstanding, long-term rules-based approach to investing. People are learning that markets are more volatile than they actually are. People are learning that fundamentals don't matter. People are learning that investing can kind of be crowdsourced by a mob. None of this is the right lesson. I do worry that half of the people are going to have this ego built on their early success that has nothing to do with real skill. And then half of the people are going to be defeated and be unnecessarily down on markets when they probably would have been fine if they had just taken a different tax. So I do worry about people learning the wrong lesson for sure.

If your early experiences are memes are the new like cigar butts, can you unlearn that? If your first experience in the market is a slot machine, can you forget that basically? Can you grow out of that? There are examples of people. I have seen on Twitter examples of highly respected financial advisors that all three of us know saying, look, my first trade ever, was this. Yeah, I think even you guys have talked about losing money early, right? Mike talked about losing money early. I learned my lesson and then that's how I became sort of a buy and hold investor. So I certainly think there are some people who will learn their lesson. They'll take their licks and they will go on to be great podcasters and financial hoopers. But I think there's a

larger group of people that are going to learn the wrong lesson, which is the market is a casino, there's no predicting these things. It's all luck. I worry that that's going to be the rule and that the Michael Batniks of the world would be the exception. Do you think people are surprised at how much trading has increased? Because the rational economists would say, well, going from $3.95 a trade to $0.00. Does that really matter that much? Obviously, it has because we've seen trading everywhere explode higher in the last 18 months or so, whenever it was. went to zero. Why is that so pervasive? Just that small change from three or four bucks a trade to zero has just unleashed this wave of day traders. Dan Ariely in particular has done great research on

how free is sort of a category unto itself. If you look at something like taking a cup of coffee from one penny to free, people will wait in line four times as long. If you take candy from being one penny to free. This isn't four bucks. This is one penny. One penny to free, people will eat four times as much candy. Free, it's a category unto itself. When we hear that something's free, we get excited. We get happy and that emotion drives over consumption of that thing. So you see options usage is up 5x in the past 10 years. We're up 500% in people's use of options. Trading has grown exponentially. So free, our friend Dan from Betterman tweeted out the other day that low cost is better than free. And it really is. Low cost really is better than free when it comes to making

financial decisions because low cost at least makes you stop and consider whether or not the decision should be made at all. When a trade is free, it's perceived as consequenceless. And that's certainly not the case. Do you think that people can compartmentalize their behavior? In other words, can we have people that act like absolute psychopaths in their taxable account and then act like boomers in their 401K? I think you can. We know about this phenomenon called mental accounting, which is that people account for and spend and invest their money differently based on how it's allocated. My brother reached out to me when all this was exploding. Again, my brother who cares nothing, he's a musician cares nothing for financial markets and he's like hey i'm going to open a robin hood account

i'm going and i'm like look man you got to wall this off have a small percentage of your money go crazy buy all the meme stocks do whatever you want but with 95% of your money you got to be to use your words a boomer you've got a buy and hold you've got a diversify so i think that people can do that and i even suggest it look if you see you're prone to this carve out an consequential amount of money and go crazy, but just leave your real wealth to grow slowly over time. How do you think we can better educate people? Because they talk about how some of these financial literacy courses don't work in some reports. Is it just that we have to use technology for good? Is there any way for a place like Robin Hood to better educate their customers and

clients? Is it a lost cause for some of these people? I think technology does hold the answer. A lot of what we're trying to do at Orion, a lot of my job is baking good behavior into the tech that we develop. We know, and this is an unpopular opinion that I will get speared for sharing here, education is sort of necessary but not sufficient. It's just not that powerful. My favorite example of this is in the early 90s, we started putting nutrition labels on food, so you know fat, calories, sodium, whatever. Since that time, America's twice as fat and three times as morbidly obese because when you're going to buy donuts, you're not like, oh, I wonder if these are healthy. You just tired. You're hungry. You want a

donut. It's not a matter of education. So the best thing that we can do is what's called just in time advice, just in time advice that's baked into the technology that says, hey, take a pause. Do you want to do this? Here's the consequences. Here's what might happen. Here's the Tax implications. Here's how this works out for people like you. That just in time advice is enormously powerful. It's much more powerful than education. Now, should we be educated? Yes. But I think a lot of what education is good for is what we call meta knowledge. So it's like knowing what you don't know. I don't know how to change attire, but I know that I don't know how to change attire. So I know when to go seek out professional help. I think education, financial

education gives people meta knowledge so they know the basics and then they know enough to know when they need to call in a professional. Start with education for that meta knowledge, but then bake it into the tech is what we've got to do. So I love what Tyro and Ross is doing on basic financial literacy, but I think that's a completely separate topic from education on trading. I'm with you. I don't think that this is an education issue at all. This is a 100% behavioral. So I'm with you. Actually, before I get to this, let's stick with what you just mentioned. If education is not the issue, can you be specific? What are some of the things that you guys at Orion are doing to nudge better behavior?

One of the things that we're doing is we're measuring risk in a new way. Most risk tolerance questionnaires measure risk tolerance, which is someone's long-term attitudes towards risk reward tradeoffs, and they measure risk capacity, which is someone's ability to take risk based on their level. Sorry to cut you off. When you say long-term feelings toward risk, you really mean what the stock market did in the last 30 days, right? No, that's what they're not measuring. In the academic literature, the risk tolerance is their long-term attitudes towards risk-reward trade-offs, and it's fairly stable over your lifetime. But then there's this third element, which is risk composure, which is exactly what you're talking

about. And that's the piece that we're baking in. It's basically someone's predisposition to get knocked off course by what's happened in the last day or the last week in the market. And it has a lot to do with their predisposition towards anxiety or stress. And so we're measuring that now. There's not many people that are doing that. We're measuring this third dimension of risk and baking it into our models. And I think that small, simple thing is going to help people make better informed decisions. We're also working on a goals-based framework to help people mentally account for their wealth in ways that helps them protect their wealth, spend their wealth, and invest their wealth in ways that are aligned with their goals. So it's really simple stuff, but it has

a powerful impact on behavior. So on the risk tolerance stuff, you're doing like EBITDA, but for risk tolerance. That's right. I love it. I've never seen something like that before. Our friend Packy McCormick has done a substack on all of the non-financial reasons why you would invest in something. So you see all of these things popping up online.

So I'm looking at this, for example, Raleigh Road. They just sent out an email where you can invest in a DC comic book, a Batman comic book from 1941, a Roberto Clemente card from 1959, a Rolex submariner, a Churchill's Second World War signature, and on and on. So all of these sort of things that, not only anybody knows what the return might be, but there are non-financial considerations. So, first of all, fun, right? It's entertaining. It's community. It's belonging. It's social status. It's all of these sort of things. Can you talk about how all of these new platforms are maybe triggering a different part of our brain that say, oh, stocks, bonds, and real estate? Absolutely. So,

I am a baseball card collector and I am a sneaker head. So I can speak directly to this. For me, it's all about nostalgia. I grew up poor in Alabama. I grew up wanting Jordans and I couldn't have them. And so now I buy Jordan ones, threes, and fours, which are not coincidentally, all the sneakers that came out when I was 10, 11, 12 years old and I wanted those shoes and I couldn't have them. Same thing with baseball cards. I just buy all the stuff. that I can afford now that I couldn't get when I was a kid. So I think a lot of this is driven by nostalgia. It's no coincidence.

I think you've seen an explosion in the price of collectible card values. When guys like us were collecting cards in the late 80s and early 90s, that was the junk wax era of sports cards. There was a proliferation of these sports cards and they're effectively worthless, most of them today. But now they're a little better regulated. And so now the people who grew up buying these junkwax cards have jobs. Now they have money. And it's tapping into nostalgia. And if you look at the returns on things like Legos, baseball cards, and sports memorabilia, they've consistently been very good. And again, it should be a minority position. It should be a small part of someone's portfolio, if any part. But I think it taps into something powerfully psychological, which is scarcity and nostalgia. Nostalgia is a great factor.

Don't you think that nostalgia can actually help people maybe have better behavior in this stuff if they care about it more than something else that they don't really pay much attention to? It's good in the same way that your house is good. I think things like Zillow have actually made us more irrational when it comes to decisions around buying and selling homes. Because before you couldn't get weekly or daily updates about the value of your house, it was fairly illiquid, it was fairly opaque with respect to its value. you just bought it and held it. And so that's why people think they've done well on houses, even though the returns on residential real estate are pretty crummy, like 2% a year in most parts of the country.

But people buy them and sit on them for 30 years and never check the price. So it feels like a big number, even if it just grew at 2% a year real. For me, I mean, my goal is to give my kids all my baseball cards. You know, I have no intention of ever selling them. And because I'm just sort of buying them and holding them for nostalgic reasons, I think, yeah, potentially, there's a reason that you become a better investor. I was more of a basketball fan, so I definitely was involved in cards and trading. And I love that. So nostalgia hits home with me.

Ben, I'm guessing that you are not a baseball basketball card collector, given that you're not a Facebook fantasy player. I have a huge bunch of boxes of cards. And my dad's inheritance to me, he's got all these cards from the 50s and 60s he's going to pass on. Hank Aaron and Mickey Mantle and all those ones. Daniel, what do you think about, I don't know if you're up to speed on like the digital card explosion that's going on? I saw your post about it. So Tops has a baseball digital cards called Tops Bunt,

and they're effectively worthless. They're worth almost nothing. But then you were posting about these NBA digital cards that you couldn't get your hands on. That's all I know about it. It's wild. If your first instance, it's like this doesn't make sense. Yeah, there's nothing more to it than that.

It's a hologram. It's a gift. You're paying thousands of dollars for gifts. But what they did that was really clever is they're partnering with the NBA to license this. A16Z is a big investor. Mark Hupin's tweeting about this. And what's happening is that you're right about the nostalgia thing. But these are people with too much money.

So as gross as the sounds, it's almost like an inequality bet for lack of a better word. Because these are people that have so much money that they're bidding these things up because they're controlling the supply. And they're controlling the narrative. Somehow the demand just skyrocket. And so literally like a LeBron James dunk went for $100,000 last week. It's wild. I start out the behavioral investor by just talking about how psychology underpins every part of capital markets, even currency, be it a cryptocurrency or fiat currency. It's worth what we all agree that it's worth. That's the case. My wife shakes her head every time I get a new stack of

baseball cards in. And I just try to say, like, look, this is good. This is investing. It is as long as we all believe that it is. All right. So Daniel, maybe a good place to leave this conversation is the psychology of group behavior where there's no real clear leader, is this going to be like the barbaric times where we get factions and people grab power? Like, where does the herd go from here? Because I think there's now almost six million people on Wall Street bets. Like, if you had to look into your crystal ball, how do you see the next few months playing out? I was on Wall Street bets this morning and there's almost nine million now. Oh, my God. I think honestly, though, the power of Wall Street bets initially was in its surprise. That's the thing about markets. Like when

everybody knows that everybody knows, it sort of loses some of its potency. So in many ways, I think a lot of these Reddit communities are great places for people to go learn about markets to get involved in things. But I candidly don't expect the likes of Wall Street bets to be able to drive the kind of price action that we saw over the last few weeks because everybody knows that everybody knows. Now you've got scrapers. There's a great scraper called Swaggy Stocks that takes out ticker sentiment from Reddit forums and talks how bullish, how bearish, breaks it down in exquisite detail. When people have access to that, the element of surprise is gone. I think they'll continue to be places where people have fun and find connection and learn about markets.

I'd be surprised if they continue to drive the kind of incredible price action that we've seen because people kind of get that now. All right, Daniel, this is so much fun. Thank you for coming on. Yeah, thank you both. Great time. All right, thank you to our Ryan Advisors, Animal SpiritsPod at gmail.com. Have a great weekend and we'll see you next week.