One Way You’re Probably Losing Money on Your Investments – Episode 71

Remember the last time your retirement account took a hit? A lot of people do. You might have questioned the quality of your portfolio and the competency of your advisor. (Your concerns might have been valid by the way). Regardless of who or what’s to blame, losing hurts, and behavioral psychologists have spent years researching how pain avoidance can influence major financial decisions. In this episode of Dentist Money™, Reese and Ryan explain how the fear of losing money can lead to losing more money. They also provide guidance for gaining emotional clarity so you can invest with more confidence.

Podcast Transcription:

Reese Harper: Welcome to The Dentist Money Show, where we help dentists make smart financial decisions. I am your host, Reese Harper, here with my trusty old co-host, Sir Ryan Isaac.

Ryan Isaac: Good Morning. Good to be here, welcome everybody.

Reese Harper: Good morning, Sir. I am going to ask you a very important question today.

Ryan Isaac: Ok?

Reese Harper: The U.S. stock market has rose almost 20% over the last twelve months as of today looking at the most recent statistics ending yesterday. You have talked to hundreds of people during that time. I want you to think back and I want you to tell me how many people have called and asked you about why their account has gone up so much?

Ryan Isaac: Whoa, ok.

Reese Harper: How many people have called and said, “Ryan, I am really surprised, I am excited about the fact that my account has grown and it seems like I have had some good growth.” How many people have called in just to say that?

Ryan Isaac: The answer to that, Reese, in the last twelve months is zero. Why? Where is everyone! Call me let’s talk about it!

Reese Harper: Seriously, let’s celebrate good times. Let’s talk about good times. “Celebrate good times, come on!” I needed to do that.

Ryan Isaac: Yes, nobody called.

Reese Harper: During this same period, there have been some things that have gone down in value, being bonds. When stocks rise, bonds typically fall. When bonds fall they do not fall nearly as much as the stock market, but they do move opposite from one another. The question for you is how many people have called to ask you about why their bonds are down during that same period of time?

Ryan Isaac: You mean low, single digit number down? Oh ya, you mean like 2.5-3% down?

Reese Harper: At most over the calendar year you might have seen 4% down. How many people have called?

Ryan Isaac: That was of particular interest during the late summer, early fall of last year of 2016. I would say easily a dozen people.

Reese Harper: About 10% of the people that you talk to in that regular scenario maybe 10%-15% called in to ask why their bonds were down?

Ryan Isaac: Yes, they were very concerned. I am not going to blame anyone, some clients have large amounts of money in bonds or emergency funds or future purchase of stash accounts. There is a lot of concern,

Reese Harper: …and it depends on if they are James Bonds, or treasuries.

Ryan Isaac: Yes, but it is true. It is interesting how much interest people were giving and how much attention people were paying to a slight loss in an account versus literally zero interest or questions about a much more significant gain in accounts.

Reese Harper: Now, we know why this happens.

Ryan Isaac: Ya, we have the answers, we know.

Reese Harper: You and I are psychological experts. No we are not, ok? We are not. We do read a lot as financial advisors. A lot of your education is focused around what is called human psychology or behavior or behavioral psychology and probably more specifically investment psychology. There is a principal that is studied, well lots of principles that are studied in investment psychology and one of them is called loss aversion. Psychologist have done decades of research on how the brain reacts to different investments and different types of returns. What we have learned is that people are much more emotionally charged and affected by losses than they are by gains. Even if they are the same amounts. We have seen this with our clients, right? Someone who has $100,000 in an account, if you lose $10,000 versus gain $10,000? We will not hear from you if you gain $10,000.

Ryan Isaac: Guaranteed.

Reese Harper: But if your account goes down $10,000, we will definitely get a call. Some of you listening to this are like, “well DUH, I never want it to go down, I only want it to go up! I don’t call people that are doing the job I hired them to do! Make my account go up, you dummy!!” Some people are probably thinking that. Your financial advisor actually doesn’t control the…

Ryan Isaac: Hold on, news flash, insert breaking news right here.

Reese Harper: Your financial advisor or investment advisor will often pretend or take credit for those gains.

Ryan Isaac: Which is why we hope that more people would call us so we could take a little bit more credit!

Reese Harper: They will often take credit, but they do not control the ups and downs as much as most people believe. The economy and interest rates and population growth and economic expansion, federal deficits, budget deficits, corporate profits, earning cycles, terrorism, all of these things come into play to affect the movement of economies. They will affect the movement of your accounts. A well educated investor knows that there are specific accounts, your 401 k will move a certain amount and a good financial advisor will help you to know what the range of movement will be that you should expect. If you have $100,000 they might say it can go up as much as 20% in a year, but it probably could go down as much as 35% in one out of every ten years. Or they will show you a histogram where you can see what to expect from your accounts. My point in telling you all of this is that most people do not celebrate their gains, they don’t feel very good about their gains as much as they hate their losses. They despise losing money, they feel very sensitive about any declining movement. They don’t celebrate the upward movement of their investments. It is just human nature. It is nothing to be ashamed about. We are not trying to make anyone frustrated or insecure.

Ryan Isaac: I will say their is a caveat, there is a small population of people who do celebrate their gains.

Reese Harper: Ok, the gym going crowd, does celebrate their gains.

Ryan Isaac: Ya, you are just saying that we see this in practice, it has been studied by a lot of people, there is just a lot more intense pain associated with loss than there is intense joy or satisfaction out of gaining anything out of your investments. Or a lot of things in life, really.

Reese Harper: Let’s talk a little bit about this, Ryan. There is a study that you have been looking into from the University of Texas that helps define this a little bit more.

Ryan Isaac: Ya, University of Texas came to the conclusion that we hate losses about twice as much as we enjoy the gains. They also found that we’re a lot more likely to act irrationally or unethically or in a more dangerous/gambling manner to avoid a loss than we are to actually secure a gain. That is what loss aversion is. The University of Texas gave an example. There is this huge bank that started in the mid 1700’s, Barings Bank. You know it well, you’ve got a few accounts there…

Reese Harper: That is where I kept in an old wooden box, in the back of the bank, is where I stored Aunt Wilma’s first photography asset. The family black and white photo.

Ryan Isaac: It was huge bank in the UK, it has worldwide reach, it was just a big deal. Even the queen of England had an account there. You might have had the box next to her, actually.
In the late eighties, 1989, there was a guy named Nick Leeson that was hired by Barings. He was a trader and he was doing really well. He lived in Singapore and became the trading floor manager. He was known for trading on the Singapore international index. The Simex, as you will, as they call it in the biz. He was kind of known as aggressive. He would make big, speculative profits, and by 1993 his profits made up about 10% of the bank’s entire profit. He had this reputation for expertise, and near infallibility. Everyone in London gave him little supervision and let him do whatever he wanted. In 1992…

Reese Harper: It sounds like Jeff, the producer of the podcast.

Ryan Isaac: Yes, very, very long leash. Does whatever he wants.

Reese Harper: He is a rogue. Sometimes he will insert random, inside jokes, into the podcast edits. Oh, Jeff…

Ryan Isaac: About the same time, there was an employee working for Leeson and he lost a little bit of money. He didn’t want that to come through on his reputations so what he did was try to earn back this little loss. Instead of just acknowledging it. He started getting even more speculative and risky. That lead to even bigger losses, which were not hidden anymore, and he kept trying to cover up his bets my coming out from under these losses. He was quoted as saying, “I wanted to shout from the rooftop, here is the situation. There are massive losses, I want to stop, but for some reason I was unable to do it. I had a catastrophic secret which was burning up inside of me yet simply I could not open up my mouth and say i have lost millions and millions and millions of pounds.” What he did was take out a short term, highly leveraged bet on the index in Japan at the same time there was a huge Earthquake and the economy collapse. He fled to three different countries, and ended up in jail.

Reese Harper: That was a quick jump to something. He was put in jail? Just going to restate that.

Ryan Isaac: Then he died of cancer.

Reese Harper: You didn’t finish the story real well there, Ry.

Ryan Isaac: He served four years, he got a diagnosis of cancer, and then he ultimately survived. The moral of the story was that this guy had this incredible career, and was very risky. One small loss, and it was very small compared to all of the other gains that he had accomplished. It was small, but it was much more painful than anything else he had done so he went to great lengths to hide this tiny loss. It ended up losing everything. It actually brought down the bank overnight. Overnight it bankrupt the whole thing and ING bought the bank. As he kept doubling down and doubling down to try and fix this tiny little mistake it brought down the whole bank that had been around for three hundred years.

Reese Harper: That is so crazy.

Ryan Isaac: At least 200 years. That was it. Back to the summary. We hate losses about twice as much as we like gains. We are much more likely to act irrationally over a loss than again.

Reese Harper: There are a lot of situations where this happens in our real lives. I think this happens both inside of decisions that dentists make or professionals make in their own finances. It also happens in the retail sector. One of the things that is a close correlation. People have a lot of defense about their purchases. The things that you choose to buy are very defensive about. You don’t express a lot of regret. Once people buy something, the secret retailers know, is that they will defend it and love what they have purchased.

Ryan Isaac: I bought a Bowflex in like 2004.

Reese Harper: You did?

Ryan Isaac: I bought a Bowflex and it was the worst stupidest thing but I defended it until I sold it for about .30$ on the dollar a couple of years later.

Reese Harper: I am still confused by that. Is it a piece of spider-man equipment? Do you put on a costume and hang from it? I don’t understand it. Sorry for all of you Bowflex lovers out there.

Ryan Isaac: There is a big Bowflex crowd, but it is true.

Reese Harper: Let’s say everyone offers the 30 day, money back guarantee because they know that once we buy something we are a lot less likely to part ways with that purchase. Just like your Bowflex, just like my truck.

Ryan Isaac: You don’t like the truck anymore?

Reese Harper: I love my truck, I still think I love it.

Ryan Isaac: But you have it? What you are saying is that there are some real world examples outside of investments, which is what we started talking about. There are some real life examples where this principle of loss aversion, which we try to avoid at whatever cost, there are real world examples that we might not even realize are happening to us? One would be, once we have an item in our possession and whether it is like the free trial, the thirty day back money guarantee, the free trial of a mattress…mattress stores are doing that now! I always think, you ship me a whole mattress, I sleep on that for a month and I send it back to you? They know that once it is sitting in my house even if I don’t like it, I probably won’t send it back. My wife would send it back and yell at someone on the phone to do it, but I wouldn’t.

Reese Harper: Part of this is not wanting to be the sucker that bought it and then you are wrong about that being a good product. Then you are going, “it was a good decision. It was a good decision. It was a good decision.” You tell yourself it was a good decision for so long that the thirty days have expired anyways. Then when you do have regret you are outside of the return period. Anyway, another example would be in a grocery store. A lot of the psychology of grocery stores is interesting. You know in the back those little plastic containers or baskets that are stored there so you can carry your stuff conveniently? Part of that is knowing that if you have a bigger basket to fill, you will fill it. That’s a side note, doesn’t have anything to do with loss aversion. They also know that once you get it inside of your cart or basket you are probably less likely to part ways from it, right?

Ryan Isaac: I’m a sucker for Oreos. I can eat a whole sleeve without even breathing.

Reese Harper: Shame on you.

Ryan Isaac: When the Oreos are sitting in there and I’m like, “I didn’t come for Oreos, but they are in my basket.” I am not going to go back. They know this. They provide a lot of convenience in carrying little things around and carts because they know that once we put it in the cart we are a lot less likely to go and put it back. The other thing I have seen is when they say, “only one left in stock. Only two, or three left in stock. That is your loss aversion speaking. FOMO as all of you young millennials say (fear of missing out). Ultimately that is a big deal. I think it illustrates the point similar to investing that you have a pain of losing money but you also have a pain of not being able to not get what you feel like is of value. There is a fear of loss ya know?

Ryan Isaac: Missing out on a chance ya know? It is the same principle of the fear of losing something is the same as the fear of losing an opportunity. If I had just asked you to tell me three phone calls you have had in the last twelve months where somebody felt like there was once in la lifetime possibility they were going to miss out on right now, with very little information or a bad feeling about it, they still want to do it because there is this great fear of losing the opportunity.

Reese Harper: Ya, podcast episode number 3, if you haven’t listened it is called Running for Miss Universe and other once in a lifetime opportunities.

Ryan Isaac: That is exactly right.

Reese Harper: I think you were impersonating Miss Universe in that episode.

Ryan Isaac: I was, you will have to listen to it to hear it.

Reese Harper: I think that is probably a good take on what happens in the retail space.

Ryan Isaac: Ya, everyday situations to paint the picture. It is not just our investing or financial behavior. We act this way with our everyday grocery shopping. I want to go into this a little bit more after a break.

Ryan Isaac: Let’s get back at it.

Reese Harper: Where we see this playing out in real life in dentists lives ok?

Ryan Isaac: These are the things that we have seen dentists do a lot more specifically with money. Number one, which we have a podcast with this too. The dentist who keeps multiple six figures account of money in the business. It started as a cushion for the business, but as it grew, it just became harder and harder to put towards anything. Pay down a debt, put in back in the business, some sort of re-investment.

Reese Harper: It started with $50,000 and now its $500,000. The next thing you know, it will be an account with millions of dollars sitting in the bank. It is tough to recover from that. You have basically spent the last seven to ten years, possibly twelve, accumulating cash and you have been missing out on a lot of growth that could come from even really, really conservative returns.

Ryan Isaac: There are two situations of fear right there. Let’s say you have half a million bucks sitting in cash, that is not uncommon at all. One fear might be that the stock market has been doing very well for awhile so the fear is that we are at a peak, I don’t want to buy in right now. It is going to crash any time now. I don’t want to put my money in… yet.

Reese Harper: That is what I was hearing in 2013, 2014, 2015, and then 2016 just happened. Like I said, the last twelve months have had significant growth.

Ryan Isaac: Same story. One of these years that is going to be right. It will peak and go down, someone is going to be right, once.

Reese Harper: Yes, once every seven to eight years someone is always right. That is why you can run the same fear mongering add on T.V. about gold being the only safe haven. Gold has not been the safe haven for the last five years, but that ad has been running on fox news every single day. It will be right every seven to eight years and everyone will be like, “see, I told you.” We know that markets go through cycles and there will be periods of time where we have a big retraction, but the problem is that people hear that and then they assume that every year it is about to happen and they sit on their cash.

Ryan Isaac: That is one scenario. The other is that it is 2009, and it has been terrible for awhile and the feeling is that this thing is not done being terrible.

Reese Harper: You got that, yes.

Ryan Isaac: I remember having conversations with clients, I think it was 2015, the market was down over 10%-12%, it finished low. That was when Brexit was happening. I remember having conversations with people who would say, “my trigger point is 10%, or 12%, or 15%,” The fear is just the same thing. If you have a bunch of cash and it has been bad news in a down market, you feel like it is just going to keep going down. Why should you write a check? We have done a whole episode on what is a rational amount to keep and what to do with the excess, but that is a real life example of someone who is avoiding the potential pain of losing money in an investment and chooses to keep a ton of cash instead. You are guaranteeing a loss by keeping a bunch of cash, but it feels less painful than the potential loss of a down market.

Reese Harper: Let’s talk about another example of loss aversion. Someone holds on to a very poorly constructed investment portfolio and has been losing money in it. Let’s say that someone has all of their money inside of gold and energy stocks. They have ridden it all the way down or another example would be they have inherited some stock from a family member at a certain point and price and that stock is shown weakness and one stock keeps declining in value. The person is not diversified, right? They only have one position and they have all this money in it and it goes down, and down, and down because they are worried that they are going to sell it at the bottom and lock in all of their losses. Sometimes that is really a tricky situation. You might just be in the middle of a cycle and you might just need to continue to ride through that, but a lot of times it is just a situation where people are holding on to something that is literally like bankrupt. It might as well be bankrupt, there is no sign of life. Sometimes they will continue to concentrate even more money in it. Just for the fear of not wanting to lose what they used to have.

Ryan Isaac: Ya, I would say that step 1 in that is defining what is a well built or poorly built portfolio in the first place. Like you said, a portfolio that declines in value is not an indication of a poorly built portfolio. It could be, however. That is where you need the advice of someone who could give you constructive and independent feedback on what you own and why you own it. You can learn what your expectations of it should be. Like you said, if the portfolio is extremely concentrated in one area and there is no diversification than that could be an indication that it is not well built. The declines that you are seeing are maybe not necessary. First, define what you actually have. Then you can determine if you are riding something down that you should get off of. Exit the roller coaster to the right.

Reese Harper: Tell me a little bit about what you see with rental real estate. I see that happening quite a bit where people have bought a property they hold onto it forever. You see that with residential rentals, commercial buildings, I think that people justify holding onto property that just doesn’t feel like it is worth what it was or what it should be because they bought it at a certain price and they don’t want to sell it until it gets back up to that price. There is a fear of loss as it relates to property all of the time.

Ryan Isaac: Ya, fear of giving up on the property. A few examples that stand out to me are particular conversation where a rental property is losing about $2,000 a month in cash flow. It would cost about $25,000-$30,000 to sell it for what it is worth, pay the bank, and get out of it. So basically in one year’s worth of cash flow losses you could get out of this property, but it is being held onto for multiple years. After that first year, you are now losing more than if you just cut a check for the difference and got rid of it, ya know? That is one thing that stands out to me and I have seen that a lot and it is hard to do. There are emotional ties to the physical properties, to what it once was valued at, when or why you bought, you just have got to put some math to it and make a call.

Reese Harper: I had a case this week actually where I was in the office, and I met with somebody who had bought a life insurance policy that they had owned for thirteen years. This is another example of loss aversion. It was something that wasn’t that great, but it had been in force for so long that it was easier to make some adjustments to it and try to improve the cost. We brought the death benefit down and lowered the cost inside of the policy and this person had grown into type II diabetes in their adult life, so it didn’t really make sense to just drop it even though it wasn’t performing super well.

Ryan Isaac: Right.

Reese Harper: This is an example, and a unique case. Where usually I see no need to keep permanent life insurance, but in this particular example someone has type II diabetes, this is their only life insurance policy, and the rest were term insurance. I was like, “oh, we are in a situation where we didn’t do the right insurance upfront, so we have to make the best of what we got.” It was amazing to see the psychological joy that the person had when I told him that. It is not a good investment, they thought they were making 7,5% a year and it had made like 1.1% over the last thirteen years. When I told him that we needed to keep this, even though the rationale for keeping it had nothing to do with it being a good investment, they were really, really relieved. I could see the visible relief that it was a good thing. It was this thing that we did for the last thirteen years and it was a good investment. Really it wasn’t, but it felt good. I guess what I am saying is that no one wants to feel like the thing they bought wasn’t a good thing. Everyone wants to be justified or valued for the choice that they made. Sometimes it is hard in life to be like, “No, you know what. We made a bad choice, and I am still a good person. I am still a smart person. I just made a dumb choice. I am not going to let my future financial confidence rest on this bad choice that I made. It was just an objectively bad choice.” That is how I would have framed this life insurance policy. It was a bad decision that they made. They should have gotten more life insurance initially that was renewable indefinitely, that wouldn’t have caused them problems when they got diabetes, you could have fixed all of the problems that this customer had with a less expensive product. They felt like it was a good decision, it was interesting to see the emotional satisfaction that they got from the fact that I said, “keep it.”

Ryan Isaac: Ya, interesting.

Reese Harper: Anyway, that was an interesting experience for me.

Ryan Isaac: Thus the podcast was born. A little light bulb. Do you ever do that, every experience or story you are thinking, “that’s a podcast.”

Reese Harper: Totally. You have heard that and you are like that is a loss aversion podcast.

Ryan Isaac: That is interesting when you get to see the joy of avoiding the loss. We are talking about all the fear of going through the loss and how painful it is, but you got to see the other side of it. Like, “oh, that felt so good to avoid that loss!!”

Reese Harper: They knew it was a loss and they had met with three or four people who have told them, “it was really bad for you.” But it was no-one that they really trusted, but they were meeting with other life insurance people. I was kind of the person just saying look at this from all of the angles. You will pay for an hour of work to do this, let’s just fix it, keep it, and move on. This will be more expensive than term insurance, but it is the right thing for your situation to keep this. They were so satisfied that they could avoid the loss that they thought they were going to incur. Anyway, I think the summary of this podcast today is that loss aversion is something that affects all of us. We put way more emphasis in our lives on losses than we do gains. Sometimes either those losses and experiences of losing money or losing a product like the example I shared. Be aware that most people associate more strongly with losses than they do gains. That is not good, especially as it relates to your investments. Your investments have to experience volatility. They have to experience losses. We don’t call them losses because losses don’t occur until you sell something, we call it volatility. We think that is the proper way to frame how you own an investment. It is volatile, it changes in price, it goes up and down, but it doesn’t lose money in less you sell it and get rid of it. I think the people experience losses in a way that almost make them discount their gains. They discount the gains that are coming from their investments, they discount the gains that might come if they took cash and deployed it because they are just fearful of losing money, more than they are excited about making money. I think that is very common. I just think it is something to be really aware of. How would you like to wrap it up with your closing thoughts?

Ryan Isaac: I think what you are saying is have the right expectations before you do things, so you don’t have an irrational sense of “losing” in one area. That is a perfect example of an investment portfolio. They do go down, sideways, and up. When you expect that from the beginning you are less likely to experience that fear and make irrational decisions to avoid that fear. My point of view is be organized with this stuff, ya know? If you have correct and accurate data then it can help you take the emotions out of the decisions you have to make. There are dozens and dozens of these cognate biases that we have. They are like glitches in our brain and thinking. We think that we can make rational decisions and we are actually pretty irrational people. Just being aware of it and checking yourself when you have a thought or are going to make a decision that it might be wrong. I would say if you are organized, you have good, clean data in from to you, you know what your net worth is, you know what your investments are actually doing, you know what you are spending, your interest rates on debt, than you are more likely to make a better informed decision driven by data not emotion. Do not let the fear of losing something hold you back from making the right decisions.

Reese Harper: I think that is really good insight. There is a big difference between trying to self diagnose and having someone help you. Even if it is a colleague or another dentist or a friend. I was talking to an orthodontist yesterday who says he used his friend, a mortgage broker, as a psychological testing ground for him to bounce ideas off of. It was interesting to see that without a financial advisor, he had found someone that he was comfortable with trusting. He found someone who could be a good sounding board. I think it is important to have someone else also question each investment decision that you make and each major financial decision that you make. Especially when it comes to buying or selling something, or a way that your assets are allocated and the way you are building wealth. Those are all great reminders on how we can all combat this.

Ryan Isaac: Thank you, Reese, for the good insight. I’ll just say, “thanks for listening”, to all of our listeners. We would love if you would take a second and go to Facebook and Instagram and give us a like on The Dentist Money Show page. You can go to DentistAdvisors.com/listen. You can see all of our episodes there and see your clients. We will respond to your loss aversion feelings here and say don’t miss out on that opportunity to be the first commenter.

Reese Harper: There is only one left!

Ryan Isaac: If you ever want to talk there are links all over our page. You can click on our calendar, schedule yourself at your convenience, talk to one of our advisors. We are always happy to talk to you and hear about your financial goals, we’d love to help you.

Reese Harper: Carry on!

Behavioral Finance