Four Harmful Investment Behaviors and How to Avoid Them – Episode 125

What do guinea worms, selfies, and sharks have to with behavioral finance? You’ll be surprised how they fit together in this fascinating episode of Dentist Money™. Reese Harper, CFP® welcomes Dr. Daniel Crosby, psychologist, behavioral finance expert, and New York Times best-selling author of The Laws of Wealth. Their discussion covers a variety of behaviors that affect the way people invest. Find out how your investment decisions might be distorted by your own emotions.

Related Resources:
Will Your Personality Cost You a Better Retirement? – Episode 19

Show notes:
Book: The Laws of Wealth: Psychology and the secret to investing success

Podcast: Money, Mind and Meaning

Dr. Daniel Crosby’s Linkedin Profile

Podcast Transcript:

Reese Harper: Welcome to the Dentist Money™ Show, where we help dentists make smart financial decisions. I’m your host Reese Harper, here with a special guest today, Dr. Daniel Crosby. Daniel, welcome to the show!

Dr. Daniel Crosby: Thank you so much! Great to be here.

Reese Harper: Yeah, man, I’m super excited, because around our office, we have had a lot of chatter from a couple of books that you have published, and we feel like they are super helpful in allowing dentists to understand how their minds work as it relates to money, and your background is going to be amazing for this interview, and I am super excited about it. So, in our office lately, Ryan came and talked to be about kind of a scary thing called a guinea worm, that I had never heard of, and it kind of freaked me out. Apparently, it is something that you wrote– he showed me in your book The Laws of Wealth where you wrote about this bug for which there is like, no cure, and it has an interesting relationship to finance and investing that I thought we should talk about. So, tell me a little bit about this guinea worm.

Dr. Daniel Crosby: Yeah, so I live in Atlanta, which is sort of the center for epidemiological research in the world, right, and so, I came across this research that had been done at the Carter Center, you know, Jimmy Carter’s philanthropic legacy, in concert with the CDC, and they had, for the first time in human history, eradicated a disease for which there was no medicinal cure; there is no pill you can take to eradicate the guinea worm. And this guinea worm was absolutely decimating the economies and the countries in much of Western Africa. Long story short, they went in, and through training, taught these folks two or three basic behaviors that allowed them to totally eradicate this disease from the face of the earth. There were millions and millions of cases in the late 90s; last year, there were just over 100, which is effectively eradicated. And so, I liken it to an investor behavior: there is never going to be some magic pill that your listeners can take to do away with all the silly things that we do with our money, but I try to make the case that just by following two handfuls of simple behavior, we can effectively make it go away.

Reese Harper: Well, let’s talk about those a little bit. If you had to explain to the average person, what are the things that most damage investors? What are the behaviors that you see having the biggest effect on people’s overall wealth-building activity and investment returns? What would you say those are, just the top three that come to mind?

Dr. Daniel Crosby: So, I’m going to do one better and go with four. One of the things that I did in my book is I took the 177 different types of cognitive errors and biased thinking that psychologists like myself have diagnosed in people with respect to money, and I looked at sort of the psychological underpinnings of those things and said, “look. Basically these things fall into one of four camps.” The first of those was ego: we want to think of ourselves as better than average; we want to maintain a competency, or felt competency, even if that happens at the expense of making good decisions. The second one is emotion: our feelings really drive our perception of risk and reward. Next, we have attention, which is the fact that something called salience trumps probability. Salience is basically how big, or scary, or easy to remember something is. So, best example this year is that more people have died in 2017 from selfies than shark attacks by a margin of five, and yet nobody thinks that taking a selfie is scary, and people are scared of sharks, because they are more memorable. And then finally is conservation, which is this preference towards maintaining the status quo, and being scared of loss. So, those are kind of like the big four.

Reese Harper: So, hitting them again. The first one was ego, and you describe that like… we want to be right, and we want to have some kind of advantage psychologically, I guess, over the average person? Is that kind of how you would describe it? How do you summarize ego again?

Dr. Daniel Crosby: Yeah, so ego is really all about overconfidence, and this is really– I mean, it is problematic with everyone, but it is especially problematic among men. I site a study in the book where 100% of men surveyed thought that they were friendlier than average, 94% thought that they were better looking than average, 96% thought that they were funnier than average… so, you know, the math doesn’t work on that. Basically, we all think we are bigger, better, smarter than we are, and we bring this arrogance with us into capital markets, and it leads us to do things like fail to work with an advisor, fail to plan for the future, fail to diversify, because we think that by virtue of us being our big bad selves, we can work it out.

Reese Harper: What was the second one? Was it feelings? I mean, you went through them pretty quickly, and I am hearing them for the first time.

Dr. Daniel Crosby: Oh, for sure. The second one was emotions, yeah. Right on. So, different emotions put us in different psychological states–

Reese Harper: So you are saying that if I’m like, pissed at something that happened to me that day, or I’m angry, or I’m sad… some event could cause me to act a certain way that I might not otherwise act?

Dr. Daniel Crosby: Yeah, so one of the things that I talk about in the book is that every decision that we make is colored by emotion, whether we like it or not. I talk about research that was done on people whose emotional centers of their brain had been damaged, and these people could not even pick out what to have for breakfast, or what color of clothing to wear in the morning, because even the simplest decision has an emotional component to it. But when it comes to thinking about money, if you are in a fearful state, or if you are pissed off, those are different things. Anger tends to make us more confident, whereas fear makes us less confident. So, the emotional state you find yourself in is going to have a direct impact on the way that you go about spending and investing money.

Reese Harper: So, wouldn’t you say that a good takeaway from that would be that, in simple terms, big decisions, or maybe decisions with your money, shouldn’t be made when your emotions are in a heightened state, whether that is angry or sad?

Dr. Daniel Crosby: Yeah, that is exactly right. So, chapter four of the book is called, “If You’re Excited, It’s a Bad Idea.” That is sort of one of my ten commandments of investor behavior. And I draw on an acronym from the Twelve Step addiction literature: it’s called HALT, and it stands from hungry, angry, lonely, or tired. In the addiction literature, they tell you that if you are in one of these HALT emotional stages, you just defer decision making, and I think the same thing would be good advice for investors.

Reese Harper: Yeah, I think that is just generally good advice in life. (laughs) I found that I make pretty bad decisions when I am in any one of those HALT mentalities; it seems like there is a good or bad time to make a decision, and it is usually not when you are in an unusual state. Usually in the morning for me is better for me than at night for some reason, too. I feel like in the morning, my emotions are more even-tempered, and at night, if I have worked really hard all day, and I have kind of ground myself down to a pulp, it seems like at night, I am less aware of the decisions– and it is never a good time to have a conversation with your spouse if you are angry, too. Night is a bad time for that, for all of you listeners who have never had that happen.

Dr. Daniel Crosby: (laughs) that is right.

Reese Harper: Is there a difference in time of day? Do you ever notice that? Does that affect people, or is that just me projecting?

Dr. Daniel Crosby: Well, I think everyone has their own time of day that is better or worse for them. I start my workday at 5:30 AM every day, and end about 3:30; I am just worthless after about 4:00, you know? So that is just the way that I operate; some people are the exact opposite. So I think it is just about knowing yourself in that case.

Reese Harper: So if you start your workday at like 11, and you are worthless by about 1:00 PM, like, what does that say about you?

Dr. Daniel Crosby: You might just be worthless, then (laughs).

Reese Harper: (laughs) Well for those of us who only have two good hours in us… (laughs) so, the third thing that you said– we talked about ego, then we talked about emotions, and then the third thing was…

Dr. Daniel Crosby: Attention. So, this is the shark attacks and the selfies, which is– you know, we don’t rate the likelihood of an event based on how likely it actually is, right? We rate it on how salient it it; how easy it is to remember; how vivid; how lurid it is. So, I mean, if we were scared about the things, as Americans, that we are ought to be scared about, we would be scared of, you know, driving to the store, or eating a hamburger for dinner (laughs), and instead, we get scared about shark attacks. And what we saw after 9/11 was that people got scared of air travel, and so they started driving everywhere, and road deaths ticked up enormously, because people were scared of airplanes, which are, on average, enormously safe, and then started driving, which is far more dangerous, because of one big salient event, that was of course top of mind throughout the nation. So, people don’t think probabilistically, they think in terms of how scary or big something is.

Reese Harper: I know my co-host, Sir Ryan Isaac, on the podcast, he is very scared of moving our office to a building that hasn’t been treated for earthquake reinforcement; that is his greatest fear, you know? So, I always give him a hard time about that, because the probability of that happening is lower, even though we are due for an earthquake at some point. It’s one of his greatest fears, and I always give him a hard time about that. So, I am going to remind him today that he has to think more probabilistically (laughs).

Dr. Daniel Crosby: Yes, and now I will give him a hard time as well.

Reese Harper: (laughs) if we both do it, and shame him, maybe he will change his behavior. But I think there is probably some bad psychology around that too, so I will let you tell me what we should do (laughs).

Dr. Daniel Crosby: Yeah, I was about to say, I am not sure if that is the route, but it could be fun anyway.

Reese Harper: So, let’s go to the fourth area, which was—

Dr. Daniel Crosby: The fourth area was conservation. So, this has two main things: people prefer to prefer the status quo over change, and they are much more pessimistic about losses than they are happy about a similarly-sized gain. So, one of the most prevalent examples in investing is what is called home bias, where people tend to over-invest in their company, in their country, and even in their geography. So, we see that people in the Northeastern U.S. are overweight financials, people in the Midwest are overweight agriculture, and people in Great Britain tend to hold 80% of their stocks in British companies, even though Great Britain is only about 7% of the world economy. So, people really sort of feel safe when they know something. And again, I live in Atlanta, which is home to a number of Fortune 500 companies, and I commonly see people who will have retired from Aflac, or UPS, or Coke, one of the other big publicly-traded companies here, and they will have 80%-90% of all of their wealth in one stock, and they think, “well, I know this. I know Coke,” or “I know UPS,” and you really really disabuse people of this idea that just because something is familiar, it is safe. You know, ask people at Enron how safe it was to have all of their wealth in Enron stock, you know?

Reese Harper: Yeah, it’s a great reminder. I was talking to someone a few months ago from Australia, and he told me that his friends in Australia like to own a diversified portfolio of Australian equities, and that is their preferred portfolio of choice, and Australia makes up even a smaller percentage of the global market than Great Britain, but he was saying that the tendency that he sees is for people to own– they will even have indexed tilted towards the small segment of Australia, and they will have 60%-70% of their portfolio in a segment of Australia. It is just interesting to see… and people feel okay with that! They feel comfortable with that. And, you know, it seems like that has been the case for quite a while.

Dr. Daniel Crosby: Yeah, that is terrifying. If you remember a few years back, some of the financial turmoil that was going on in Greece: Grecians, on average, held more than 90% of their equity holdings in Greek stocks, and that is just absolutely unfathomable! But yet, you know, that is what we know, and it feels safe. But especially small countries like Greece that have very very very specific niches around agriculture and tourism and things… I mean, you are just not exposed to a variety of sectors and countries.

Reese Harper: So, let’s switch gears just a little bit. Most of our audience is not really familiar with the science of behavioral finance. To many people who are not familiar with finance in general, they would be surprised to learn that there is an actual field in psychology related to money, and numbers, and finance, and how people interact with financial topics and economics. Can you kind of describe what this is, this field of research? I think people would be surprised to know that there is a PhD who was spent his life studying this, and that it is an academically rigorous field.

Dr. Daniel Crosby: Yeah, so whenever I am on an airplane, which is often, someone will go “oh hey! Where are going? What do you do for work?” and I tell them that I study the intersection of finance and psychology, they kind of look at me like, “that can’t really be a job,” and yet, you know, here we are.

Reese Harper: “Did you make that up?” Like, “yeah” (laughs). “Is that a job you gave yourself?”

Dr. Daniel Crosby: “And you can afford a plane ticket?” (laughs) so yeah, that is really what it is, it is about studying the psychology of human behavior around money, and so for me, it is around investing in particular. One of the things that I like to tell people because it is true is that God could not have designed a worse investor than you or I; every impulse that we have nearly runs contrary to what we should be doing in financial markets, and we have really adapted and evolved, as the human species, to reproduce and not die, and historically, we have not lived that long, and so we are not really cognitively wired to prepare for the kind of lives that we need to prepare for now! Which is, you know, I have young children who, when they were born– when my youngest child was born, they said, “40% of she and her peers will live to be 100 years old.” So, we are not wired or prepared for 30 years of work and then 30 years of retirement. It is a very uphill battle, and I am grateful that there is a discipline devoted to it.

Reese Harper: So, what did you do to get– what types of topics were starting to peak your interests that led you down this road during both your undergrad and graduate studies? When did you kind of understand, “I am going to study this topic,” and what made you kind of go down that road?

Dr. Daniel Crosby: So, what is fascinating is that it has only been in the last couple of years that there are dedicated programs in behavioral finance at universities, and so most of the older behavioral economists are either psychologists who have learned about finance or economics, or economists who have learned about psychology. And so, I am a clinical psychologist by education; my bachelor’s and PhD are both in psychology. I am the son of an investment advisor, my dad is a financial advisor, and so I grew up sort of steeped in this world, and hearing stories, you know, de-identified stories of client misbehavior, and so when I came across it, at the time, I was vetting bankers pre-hire, I was working for a SunTrust Bank here in Atlanta, giving IQ tests and psychological batteries to banking executives pre-hire to see if they would get brought on board. And so, when I came across this hybrid field of behavioral finance, I was immediately drawn to it; it sort of spoke to both of my great loves.

Reese Harper: Wow, that is interesting. So, tell a little bit– related to this, there is a lot of research that tries to quantify investor behavior; there are a lot of different industry studies that show that people actually don’t do as good of a job at investing as they think they might. Can you talk about some of the most prevalent studies, and what they kind of show, and what they demonstrate?

Dr. Daniel Crosby: Yeah, so I cite them all in chapter two in my book; there are seven or eight big ones; all of them speak to what is now known as the behavior gap. So, the behavior gap is this discrepancy between the returns that the market provides, and then the returns that accrue to the average investor based on their behavior in the market. If you look at the past 30 years, the market has return on average about 10% annualized, which is pretty much right on board with its long term average. The average investor in the market has gotten over 4%, and inflation has been about 2.5%-3%. So, it is pretty incredible to think– and the people on the airplanes are always sort of shocked to hear that if you are an average investor, and you are, right? If you are an average investor, you are not hanging on to a fraction of what the market gives you, and that’s why I am a big proponent of having people work with advisors, and I spend a lot of time positioning a financial advisor’s greatest value as not necessarily stock picking, or even asset allocation, but basically, behavioral coaching, and keeping you from being your own worst enemy.

Reese Harper: Let’s talk about this just a little bit: so these studies show that people earn a lower return when they invest in stocks than the market earns, right? That is what most of the studies show, and some of them show big discrepancies in what that difference is. If the market return is 10%, some might show that investors are doing 4%-5% worse than the market, and some might show that investors are doing as low as 1%-2% lower than the market. As you have looked at all this research and all of these studies, what is the consensus that you have come to? Because it seems like there is a fair amount of disparity between how different studies measure the return differences. All of them are concluding to the same point you made, which is that there is a big difference between what people are earning from their investments and maybe what they could earn, but why is there a discrepancy so much in these, and what do you think really is the rational takeaway that you have had in your research?

Dr. Daniel Crosby: Yeah, so the differences can be everything for whether or not they count for fees– you know, some of them are gross of fees, some of them are net of fees, some of them are time-weighted returns, others are dollar-weighted returns– I mean, there are a couple of different things there. But you are exactly right that while the magnitude of the gap is sort of up for discussion– is it 2% or 2.5%, or is it 5% or 6%– the fact that a gap exists is sort of indisputable; that is something that every study finds. There is even more dramatic evidence– in The Laws of Wealth, I talk about how the best performing mutual fund of 2000-2010 was a focused equity fund that returned 18% a year annualized for ten years, so absolutely incredible performance, you know? You would have doubled your wealth a couple of times in ten years at 18% a year, and the average investor in that fund realized a return of -11%, because the fund would run up, it would be super successful, people would take notice, pile in, it would then go down for a while– we would have a period of mean reversion where everyone would jump out and think that the ship was sinking– and then it would run up again and everyone would pile back in. So, you could argue around the margins how big the gap is, but I don’t think there is any denying that it is there, that it is meaningful, and that financial professionals, one of their main jobs should be to try and mitigate it.

Reese Harper: Well yeah, and one of the interesting things for me is that a lot of dentists we talk to will say, “but I use Vanguard, and I use index funds, and so I don’t really need to hire someone, because it’s not that complicated,” or “I use a target date fund at Vanguard,” but I don’t think that most people are– Vanguard actually, in the last five years, has really come out their own research around what they call “Advisor’s Alpha,” and I am sure that you are familiar with that. Can you just talk a little bit about that? I think it is a little bit ironic sometimes that the people who feel like, by circumventing a financial advisor and going directly to an index provider like a Vanguard, that they are following the right approach by avoiding hiring someone, but that same institution is publishing research that there is still this behavior gap that their own data is supporting.

Dr. Daniel Crosby: So, it goes to the means by which financial services have been marketed to the masses over the years, and I think Wall Street is largely to blame for this, and is now sort of reaping what they sowed. For so many years, Wall Street marketed to folks that the important thing to get right is asset selection and asset allocation, okay?

Reese Harper: So you mean by asset selection, you mean picking the right fund, or picking the right stock, and then making sure you have the right mix? Is that what you mean?

Dr. Daniel Crosby: Yeah! Picking the right stocks, or funds, and making sure you have the right mix. That, frankly, is not that hard to do. What is enormously hard to do is to sit with that through thick and thin, and to not capitulate. Now Vanguard, you are right, published a study that talks about all of the different value that accrues to someone by virtue of working with a financial advisor, and in their research, they put that at 3% a year. But what is cool about that Vanguard study is that they actually ascribe a point value to the different activities that comprise an advisor’s day. And so, security selection and asset allocation, they put at 35 basis points. So, you know, 35/100 of 1%– about ⅓ of a percent– of the value that an advisor adds is added by choosing stocks, and choosing funds, right? And that is what Vanguard does, for crying out loud; that is what they are selling. But five times that value is added by that financial advisor helping to keep you from being your own worst enemy. So people who fall into this trap of saying, “yeah, I am going with Vanguard, and this is how I’m going to do it: I have a target date on…” they have gotten one important piece of the equation right, you know? They have managed their fees, they have diversified, presumably, but they are missing one very crucial piece, and in my experience– this is non-scientific, right? This is just sort of anecdotal and observational… I think that there is about 10% of the world that can really do it themselves, and they can really sort of set it and forget it, and use a Vanguard, and do it themselves, and I feel like there is about 10% of the world that is just sort of reprobate day traders (laughs), and you are never going to get them to settle down and pick a conservative style, and sort of act right. But for most of us in the middle, we need help! And I have put myself in that category too; I pay a financial advisor, because even doctor of psychology, New York Times bestselling author on behavioral finance, I know that I am just as stupid as the next person is on the line, and I get scared.

Reese Harper: Yeah. It is probably surprising too– I have told my audience this quite a bit– that when I have to make hard financial decisions, or I have to make hard investment decisions, I have to depend on Ryan, because I need my partner in the business who is an experienced financial advisor to really tell me the difference between the truth and the lies that I am telling myself. It is crazy, but it is kind of interesting for me to see how difficult it is for me to make the right financial decisions on my own, even though I am able to objectively and easily do that for everyone else, because I don’t have any emotional skin in the game when I give advice to a client, but my own emotions are harder for me to navigate. Sometimes I can justify doing things that I wouldn’t normally advise a client to do, just because I feel like it is difficult for me to control my own emotions, my own temperament, my own preferences… control my own spending patterns, and critique myself with the plethora of financial choices that I have to make as an individual, and as a business owner. It is really hard! And so, I strongly believe in having someone else provide that behavioral gap, you know? It helps shorten that, and shrink that behavioral gap, even as a financial advisor, and I think you would agree with that.

Dr. Daniel Crosby: I absolutely do, and it’s based on this mistaken notion that we have that if we know the right thing to do, then we are automatically going to do it. You know, I travel a lot, and I liken it to me walking through an airport, hungry after a long day of work, trying to decide what I want to eat, and choosing to eat a cinnabon over a salad, right? It is not because I have any misgivings about the nutritional content of a cinnabon over a salad, right? It is just that in that difficult emotional moment, one has sort of a level of ease and comfort, and the other one is the hard thing to do but the right thing to do. And that is what an advisor is good for. Even if you know the right things to do… we all too often don’t do them.

Reese Harper: Yeah, that is really good insight. So, I want to hit that Vanguard study just a little bit more, because they talked about a few other things that they were able to quantify, and some things that they were not able to quantify, that they still felt like were important. You said it was roughly about 3% that they were attributing to a lot of different things that a financial advisor can do for someone… some of those things– I was kind of surprised when they started quantifying them, or the value of a few of the issues that really are a little bit technical, and that might not relate as often to psychology, things like rebalancing properly, maybe with new cash flow… like when you make a deposit into your account, making sure that it goes to the right investment to keep your account in line… I think that is a really important factor. And behaviorally, what I have noticed is that when people manage their own money, they often neglect the proper rebalancing of their investments, unless they buy a target date fund. And so, they buy a target date fund, the fund automatically puts their money in a diversified mix, but that comes with some negatives, because when you go to withdraw money out of that fund, you are also selling things that might be the wrong thing to sell during a really declining– if you are in a 60/40 stock-to-bond target date fund and the market is imploding, you might want to sell some of the bonds instead of selling the stocks at that moment if you need five grand, or ten grand, but you can’t really do that, because they are all in one fund. So it is almost like, during the accumulation phase, it seems like it is really comfortable for a lot of people to just use a target date fund, and that is the only way they keep their money invested properly, but if they use let’s say a really simple four or five mutual fund portfolio, where they diversify globally, and they have the right amount of mix in equities between Europe, and the U.S., and Asia, and some bonds that give them the right asset allocation, they leave a lot of money in cash! I mean, a lot of times, they will go four or five months, and there is just a lot if money sitting there that they deposit, and don’t get around to investing… I don’t know, for me, that was kind of interesting. Obviously, I have a dog in the hunt as a financial advisor, and I get paid to do this for people, but I have tried to be objective just looking at the success that people have on their own, even if they are really capable, qualified, and confident, and it seems like anecdotally, at least– because this is maybe only 100 interactions I have had with self-directed investors– they end up leaving a lot of money sitting in cash and never really invest it, or they end up doing a target date fund, and both of those extremes are not really optimal, right? I mean, I don’t want to say that a target date fund is not optimal for some investors; it really can be for certain cases. But those seem kind of like not optimal outcomes, and they are driven by a behavioral factor that I don’t know what is driving that… if it is just lack of time, if it is just laziness, if it is just not getting around to it because you are too busy, but it seems like that is what I am observing. Do you having anything in your career that you can speak to in that regard?

Dr. Daniel Crosby: Yeah. If we go back to that conservation pillar that we talked about earlier, people tend to be status quo oriented; they tend to be change averse. The other thing that we see very consistently– I am having trouble citing chapter and verse, here, but very very consistently, we see that self-directed investors misremember their returns. Like, people very very much overestimate how they did, and especially how they did relative to the market. I have a friend who is a self-directed investor, and she has done quite well; she has done a great job with saving, and has accumulated a nice nest egg at a young age. She contacted me the other day and said,” hey, I think I wanna go into your business! I want to go into the financial service business, because I am generating such excellent returns in my stock portfolios. Would you mind taking a look? Because over the last five or six years, I’ve done really well,” and she had underperformed the S&P by about 3% a year!” It is people confusing a bull market with brains, and that is a very big problem. So to your second point, there is a whole section in my book where I talk about the power of rebalancing; it is one of these simple but profound things that we do. The example that I give is I talk about a multi-decade period in equities, and I look at Asia, Europe, and the U.S., and I give the example of if you had equal weighted Europe, Asia, and U.S., and just rebalanced them one a year, right? I think the numbers– over that 20-year period– the average of those three was 10.4% annualized returns, but the average of the portfolio that rebalanced every year was 10.8%, because effectively, what you had done was bought low and sold high by rebalancing. And so rebalancing, in a very real sense, is one of those things that seems easy and in fact can be quite easy, but is locking in a positive behavioral tendency to buy low and sell high that everyone knows and no one does.

Reese Harper: I guess to that point– I really appreciate you sharing that. In my experience, one of the difficult-to-measure factors is what I’m kind of highlighting, which is that a lot of the statistics can measure the effective rebalancing in a portfolio that always remains invested, right? But the thing that is difficult to measure is how much cash ends up sitting around in people’s bank accounts that they don’t invest because they are emotionally unable to commit to deploying the capital? Like, I don’t know how to measure whether… you know, you can measure cash balances in the American population’s bank accounts, right? I can measure cash balances in my clients’ bank accounts, and those stay invested at a very high percentage, but I can’t really get data on the average person who is out there, and how often they have money that could be invested but that they let sit around, and my assumption is that there is a lot of money throughout someone’s lifetime just sitting around in bank accounts, because no one has assigned a tangible goal or investment objective to that money. To me, I feel like there is a big opportunity for most people to retire at an earlier age, make work optional at an earlier age– as you stated, we are probably going to be working until we are 79 years old since we are living to 110 now (laughs), but making work optional is still a goal that I think all of us would like to have, and for most of us at as early of an age as possible. It is fun to work when you don’t have to work. And so, it just feels like cash sitting around is at least a big factor for our dentists. The data we have is that when we interview a new client, we can see how long they have been sitting on a certain amount of cash, and it is always surprising to me that there is a much larger percentage of bank account balances just sitting there for most of these high-income professionals, and they have just never had the confidence to do anything with it. Even though they are a self-directed investor, even though they have an IRA, even though they have a brokerage account, there is just a disproportionately high amount of cash sitting there, and I think that that cannot be overstated that that is a really difficult thing for most people to get their hands wrapped around. And like you said, the status quo makes you be able to let it sit and not have to do anything about it, and it is easier than actually taking action (laughs), so…

Dr. Daniel Crosby: Yeah, absolutely, because you have the status quo working there, and saving money is very much perceived as a loss by people; that is, psychologically, how it is experienced; it is experienced as a loss.

Reese Harper: Just for people who are not as familiar with that, what do you mean by psychologically experienced as a loss? Like, when I save money, what is the psychological pattern that I am experiencing?

Dr. Daniel Crosby: There is something called prospect theory that one gentleman by the name of Daniel Kahneman, a Nobel prize, he quantified how much more we hate loss relative to how much we like gain, and what he found is that we hate loss two-and-a-half times more than we like an equivalent-sized gain. When you look at fMRI scans, brain scans and things like that, or even just do interviews with people who are saving, it feels very much like it has just been been blown to the wind (laughs). And you know, nothing could be further from the case; you are setting up the kind of life that will allow you to do all of the things that you talked about, and make work optional, but it is perceived very much as a loss, even though it is finally accruing some gain once you have saved it, and invested it.

Reese Harper: Why do people experience investing in real estate differently than they experience investing in… let’s say Vanguard’s VNQ real estate REIT? Like a mutual fund or an ETF that is investing in commercial real estate, or residential real estate? Why do people experience investing in a rental property, or a home, or an investment property differently than they experience investing in a public investment? Do you have any insight into that?

Dr. Daniel Crosby: Yeah, so I had a friend over recently who is French, right? He is French; he is here working in Atlanta. I asked him, and I said, “hey, don’t tell me numbers or anything,” but I was trying to assess him for home bias, because that is what kind of friend I am, I guess. (laughs) so I was saying, “how do you allocate your wealth between France and the U.S.?” And he said, “oh, I don’t invest in markets, that’s like gambling. I invest in bricks.” And I said, “what?” And he said, “I invest in bricks; I want to own something physical.” And he had a bunch of duplexes in France. So, in his hometown in France, he had a lot of duplexes. Well, so… I think that the mistake that people make here is that think, because it is it physical, that it is more real. You know, if you invest in VNQ, you can’t see the commercial real estate in the hospitals, or wherever that REIT is putting their money, but if you own a duplex in Sandy, Utah, and you can touch it, and you can go see it, and put your hands on it… I think it feels more real to people. I would tell you, I would take VNQ over brick and mortar all day long, if only– to say nothing of the diversification– if only to reduce the hassle–

Reese Harper: Yeah, and the liability, and the cost.

Dr. Daniel Crosby: Oh my gosh. Crazy.

Reese Harper: I had to example of this that were interesting to me. A couple of days ago, I got a call from someone who said, “I invest in rental properties, because it is just a lot less expensive than paying all these financial advisors to invest my money for them,” and I just showed them a quick example on this $200,000 rental that they bought, and it was almost $200 a month in expense they were incurring in property management fees, and that is not to take into any consideration the amount of rehabbing, roof repair, appliances… you have to allocate some kind of a rational percentage, so let’s just say 1% of the value of the home– super conservatively– as an extra expense… you are looking at like, 6%-8% per year in fees related to that asset that you are holding, and it doesn’t have the same tangible, evidence-based, historical return, or the evidence-based diversification that you would get from something else, but I think cost is a factor that people just don’t– they associate a percentage against an account at what feels like a much higher psychological loss to them than $100 a month, or $200 a month towards a different type of fee. And I know that that can work both ways, but that has been kind of surprising to me, and I don’t know if you have any experience looking at the difference between percentage-based fees, versus hourly, versus fixed fees, and what consumers prefer… I am kind of curious about your perspective on that.

Dr. Daniel Crosby: Well, I have noticed advisor friends of mine who charge a flat fee– which I think is a great way to do things, and a perfectly lovely way to go– I have found that they run into more obstacles than advisors who charge a percentage, just because it is sort of an, “oh! What’s all this money for?” versus, you know, the other way. But what I will say about real estate, though, is Robert Shiller looked at real estate in the U.S. and found that over the last 100 years, real estate has appreciated at about the same rate as inflation, which is to say basically not at all in real terms, and the reason that we do this is because we confuse nominal dollars with real dollars, right? We know that grandma bought her house for $100,000, and she sold it for $400,000, and that sounds like an amazing return… well, we don’t account for the opportunity costs, and we don’t account for purchasing power and inflation. So, real estate stuff tends to be really misleading, and I am not personally a fan.

Reese Harper: Yeah. So, (laughs), one thing I want to get your opinion on… imagine we walked home every night to each of our homes, and above the front door, when we are about to walk in, there is a ticker symbol sitting there that has the value of our home on it above the front door, and all throughout the day, it moved up and down, and when someone’s pipe broke, you saw the value of their home decline when they had a water leak. Because if the market of home buying was so efficient that all of the flaws, frailties, the rot, the depreciation, the community events, and community activity that sort of drove the price of homes to be transparent… if all of this was priced so efficiently to where a ticker symbol could be on the front door of our house, and it would go up and down every day, my assumption is that we would hate our homes as much as we hate the stock market (laughs), and I feel like it is price transparency, the honesty of a stock market… I just love the honesty of the market, and how transparent, and objective it is, and I feel like some other investments don’t offer that level of transparency, and we almost love to not know the truth. But when we know the truth, we tend to almost hate the truth. And I feel like the market is a love–hate relationship for people because of that price transparency.

Dr. Daniel Crosby: Well, I wrote about a bank in Europe that wasn’t getting people to use their ATMs, and what they found that the thing that they had to do was stop telling people how much money they had, because people were scared to look at their bank accounts, or scared to transact, because they didn’t want to realize how broke they were. And I think there is something similar; you are being too rational about it (laughs). You know, the transparency that you love for other people to fear, they don’t want to be able to see it all the time. I think you have nailed it.

Reese Harper: Yeah, that is interesting. Well dude, we could talk for a couple of hours; me and you could go on forever, but I am going to have to have you back on, and we will take a version two of “Dr. Daniel Crosby Unveiled: Raw and Uncut.” (laughs)

Dr. Daniel Crosby: I love it! Absolutely.

Reese Harper: Well thanks so much for joining! Any parting words you would like to leave people with? I just want to let you have the last word.

Dr. Daniel Crosby: Yeah, my last word is my first chapter from The Laws of Wealth, and it is, “you control what matters most.” I hope that is what people walk away with: a sense of empowerment to know that more than presidential politics, more than geopolitics or the economy, simple decisions about your behavior, like saving enough, working with an advisor, managing your fees, these are what is going to get you across the finish line. So, that is my parting word.

Reese Harper: Thanks, Daniel! I really appreciate it, man. There is a lot of good content here today, and a lot of people will be able to get in touch, and get more insight. I really appreciate it.

Dr. Daniel Crosby: Alright, thanks Reese!

Reese Harper: I’ll talk to you soon.

Behavioral Finance