So I went to school and got a PhD in basically being a shrink, right? Like I went to school to learn how to be a clinical psychologist to talk to people about their problems with anxiety and depression and things like that. I found about three years into my program that I wasn’t loving it. I wasn’t loving that work. And it was just taking a pretty heavy toll on me. And so I loved studying human behavior. I loved thinking about why people acted the way that they did, but I wanted to do that in a non-clinical setting. And so my first job out of my PhD program was actually working with a bank to assess executive talent pre-hire. So I would give them IQ tests and personality tests and things like that before they would come on board.

And that’s where I discovered this world of sort of mind and markets, you know, learning about behavioral economics and thinking about the way people make decisions with their money and the rest is history there. I just sort of, you know, started to pursue that in earnest and found it to be a fantastic niche. So you know, now at Brinker, I’m in charge of basically helping financial advisors to help their clients. You know, our clients are financial advisors. And so I help financial advisors help their clients to make good choices with their money, which is, as it turns out, incredibly hard to do.

Robert Leonard  02:41

Yeah, it’s interesting because a lot of times financial advisors are supposed to be that person that helps their clients maintain their behavior. So it’s interesting that you’re helping financial advisors maintain and have successful behaviors themselves.

Daniel Crosby  02:53

Well, you know, I think smart people always get a coach right. You know, it’s interesting when people ask me if I work with a financial advisor. And I do, you know, I have written three books on behavioral finance. I could tell you chapter and verse of every study that’s ever been written about all the silly things we do with our money and what you ought to do with it. And yet I pay someone to help me manage my money. Because I think smart people and humble people know that even if you know a lot about a subject, that’s a very different conversation than always doing the right thing. So yeah, I think coaching is an invaluable thing in this world of financial decision making for sure.

Robert Leonard  03:33

And that’s exactly why this has become one of the most fascinating things that I’ve studied personally related to finance over the last five years or so. It’s not necessarily directly about finance. It’s obviously about human psychology. What is behavioral finance and why does it have such an impact on one’s investing success?

Daniel Crosby  03:51

Well, so my sort of go-to definition of behavioral finance is it’s the study of markets with the messiness of human beings thrown in them. You know, if you look at the way that market assumptions have been modeled historically, a lot of times in standard finance or standard economics, you’ve had simplifying assumptions about the way that markets work, that just assume rationality across all market participants. And that’s, you know, definitely not the case, we’ve seen time and time again. So behavioral finance is just finance that accounts for human nature.

And you know, I’ve written articles that say I have three young children and I hope that when my children go to college, they’re not able to take a course in behavioral finance because I hope that the idea that finance is anything but behavioral will be so you know, long gone that just, it’ll just be finance at that point. And it’ll just be second nature for us to account human tendencies when we’re talking about finance, because of course, you know, human beings are the fundamental units of capital markets, right? I mean, we are the ones that determine the worth of the different things we trade and bid on. So I mean, what are markets if not behavioral? So that’s sort of what behavioral finance is, in a nutshell.

Robert Leonard  05:09

It’s so interesting, because when I was back in college and my undergrad, and even my MBA program, we didn’t study behavioral finance at all. It was more historical, more theoretical formulas and modeling on what stocks should be valued at. How have you seen what’s being taught in colleges that theoretical finance compared to behavioral finance in the actual markets?

Daniel Crosby  05:30

Well, I mean, we’re looking at a really fantastic example. That’s top of mind just in the last couple of weeks. So traditional finance would say the price is always right, you know that the price of an asset always fully reflects all the information that’s available about that asset. So effectively, the price is always right. So you know, it doesn’t do any good to sort of time the market. It doesn’t really even do that much good to do fundamental research because whatever the price is, is what’s accurate, right? Like it’s reflected in the attitudes and the information of all market participants.

When you look at something like We Work, you know, We Work two weeks ago was worth $50 billion. And then some, you know, stuff started to come out that, you know, like, “Oh, well, maybe we don’t like the character of the CEO.” And then it dropped to 40 billion and then to 30, and then on to 10, and then to seven, and they just pulled the IPO. And what’s fascinating is no new information came to light during this time. It’s not like there was some huge revelation about We Work.

Everything that bled to the ultimate pulling of that IPO had already been in the press, you could argue that it got wider play. You know, you could argue that it got picked up in some more prominent journals as it went to IPO time. But you know, for something to go from $50 billion to $7 billion to then not available, in this spam of a couple of weeks, with no new fundamental information coming to light, like that’s behavioral finance in a nutshell, is that it’s at least as much about sentiment and psychology as it is about intrinsic value. And it shows you how wild these things can swing and how much savvy investors need to account for things like investor psychology.

Robert Leonard  07:22

Yeah, We Work is such a great example. I’m so glad that that’s taking place right now so we can talk about that. How about outside of the stock market? Where have you found behavioral investing having a big impact? How about real estate or cryptocurrencies? Does it take place in those markets as well?

Daniel Crosby  07:36

Let me speak about both of those markets because I think they’re good examples. You know, I meet so many people, I travel a great deal. I meet lots of people and when I tell them what I do, everyone you know is like “but like a psychologist that studies the stock market. Like that’s not a real thing.” So you know, but like, I meet these people and I get to talk to them and hear you know, the people I’m sitting next to on a plane give me their you know, candid insights into markets. And one of the things that I very very commonly hear is “I don’t like to invest in the stock market, which a lot of these books will refer to as being like Vegas.”

know, all the stock market is just like… it’s like Vegas, which is, you know, of course it’s not, but they’ll say, you know, “I like to invest in, you know, bricks and mortar, like, I like to invest in real estate and I invest in my home,” which, you know, I’m speaking to you from my home. I’m a homeowner, I’m not against that.  But you know, a home has a number of interesting characteristics that make it a more comfortable investment than say stocks for a lot of people.

You know, think about your home. Your home has historically been pretty illiquid, and you haven’t known, minute to minute, what your home was worth, right? You didn’t drive home and you know, there’s not a sign in your front yard that says, “Hey, your home is worth 2% less today than it was yesterday” for you to panic and freak out. And so people like to invest in real estate, because in a way it forces them to be good behavioral investors. That sort of ties their hand, you have to be a medium to long term investor unless you just want to invoke some pretty significant turn fees, when you know what you’re doing flipping houses, you know, it’s been opaque. It’s been illiquid.

And oddly, those are things that have made it a really attractive investment from a behavioral standpoint, even though if you look at Robert Shiller’s research on residential real estate, it has appreciated at about two and a half percent a year in the US over the last hundred years. Like it’s keeping up with inflation, it sucks. It’s a terrible investment. But people think it’s great because they don’t have to watch it go up and down every day. They can’t check the price on their iPhone and freak out about it.  Now, interestingly, Zillow is kind of changing all that because you know, every month I think it is,I get a thing from Zillow with my home and it says, “This is what your home is worth now.”

And it’ll swing pretty wildly, you know, I mean, it’ll swing five and six figures swings since the time I bought it, and so it’ll be interesting as technology improves and things like Zillow come into play. Will people start to panic and freak out and make the same mistakes with their home that they have done historically with stocks? Maybe.  And then cryptocurrency is just an incredible example because in many respects, cryptocurrency is no different than currency. I mean currency, the only reason that you and I spend our days toiling away for a little green pieces of paper is because we believe in it, right?

I mean, this is backed by nothing more fundamental than our faith, our belief in this system of the little green paper getting us the stuff we want. So cryptocurrency you know a lot of people poopoo it, but cryptocurrency is no better or worse than regular currency in that respect. It’s just newer, and it’s unproven. So you know, cryptocurrency isn’t really backstopped by anything fundamental, the way that a house is. Any asset you would choose has an element of behavioral psyche to it.

Robert Leonard  10:59

You think that the run-up to 20,000 was driven primarily by behavioral psychology in cryptocurrency markets and specifically with Bitcoin?

Daniel Crosby  11:09

Yeah, I mean, I’m no expert here, I wouldn’t begin to know how to put a value on cryptocurrency because you know, there’s no dividends. I can’t do a discounted cash flow analysis on it, you know, I can’t, it doesn’t keep the rain off my head. But that’s not me knocking cryptocurrency. It might turn out to be wonderful, but it shows you… You know, the run-up to 20,000. And then the precipitous drop since then, all of these things are investor psychology, and you know, it’s probably too much on the upside and probably too much on the downside. But one thing that’s true about human nature is we tend to project the recent past into the future indefinitely.

Like this is one of the things that we do. So when Bitcoin was climbing from five to 10 to 15 to 20. People would look at that recent past and go, “Oh my gosh, like, you know, Bitcoin is never coming down.” Like the same thing on the way down, you know people see it getting halved and people seeing it dropping precipitously and they go, “Oh, this is all that’s ever going to do.” You know, the truth is probably somewhere in the middle because trees don’t grow to the sky, right? It’s not going to go up forever. And so we have to be careful to account for mean reversion in markets because we tend to think that whatever’s happened in the recent past is going to keep happening forever. And markets have a way of proving that wrong.

Robert Leonard  12:31

Not only in the cryptocurrency market, but in the stock market as well. There’s been a lot of examples I think of FOMO, fear of missing out, and you’ve developed a framework, a popular framework of principles that someone can use to manage their behavior when investing. Can you share with us those principles and how someone can manage their emotions more successfully when investing?

Daniel Crosby  12:51

There’s these four biases that I’ve coined. So I looked at the research into investor bias and found that there were over 177 different cognitive errors that we fall prey to, which is, you know, crazy. How do you account for, you know, not doing 200 things wrong? And so what I did was I drilled down into these nearly 200 things and said, “Okay, what are the sort of psychological tendencies that underlie these 200 things because they’re not all that different.”

And so the thing that I walked away with was four things. The first was ego, which is this tendency of ours to be overconfident. The second is emotion, which is our tendency to let our heart run away with our head. The third was conservatism, which is our tendency to be sort of lazy and prone to the status quo and being risk averse. And the final one was attention, which is the tendency for us to evaluate the likelihood of something not on how probabilistic it is, mathematically speaking, but how salient it is psychologically.

Many more people die every year taking selfies than are eaten by sharks. And yet, you know, we’re scared of sharks and we’re not scared of taking selfies because the shark attack is, you know, the shark attack is much more salient. We can imagine it, we can envision a shark attack more catastrophically and more vividly than we can envision, you know, drunkenly stumbling into the road while taking a selfie. Those are sort of the four major investor biases that I identified in my books. And, you know, I feel like if we can develop frameworks for keeping those things in check, you’re sort of on your way.

Robert Leonard  14:30

You’ve also talked about the idea of worrying less about the economy and becoming more focused on my economy. Can you please expand on that a little bit for us?

Daniel Crosby  14:40

In my book, “The Laws of Wealth,” I set forth what I call these 10 commandments of investor behavior. And the first one is that you control what matters most. And so what I find in when I’m out speaking and lecturing, is that most people have questions about externalities. You know, they want to know things like what’s President Trump gonna do with trade or you know, what’s North Korea going to do with their missile program or you know, what’s going to happen with Brexit. So they’re, you know, they’re sort of worried about political, geopolitical stuff that’s outside of themselves. And all this time, they’re not doing the blocking and tackling like, they’re not automating their savings, they’re not taking appropriate risks.

They’re not working with a professional who can keep them on the straight and narrow. And so most people are worried about the economy, but don’t even have their own houses in order. So that’s, you know, sort of step one.  And then the second thing is there’s also a lot of research on how personalizing a program of saving and investing can lead you to make better decisions. You know, there’s research that shows that people who looked at a picture of their children before making a saving decision, save two and a half times as much as those who didn’t.

There’s research that people who name their accounts, you know, like, this is my “go to Hawaii fund,” people who name it with their values and the things that are important to them, they’re three times as likely to stay the course, or two times less likely to blow all the cash. Just personalizing the process, making it personally meaningful and that my economy sense, is a way to get you focused on the right things. And it’s sort of a weird psychological trick to get you doing what you ought to be doing.

Robert Leonard  16:21

Shifting away from investing and a little bit to personal finance, personal finance is relatively simple concept to master. It’s not easy, but it’s simple. Spend less than you earn, save and invest the difference yet so many people still struggle with getting their finances in order. How does someone’s psychology play into to managing their personal finances outside of investing?

Daniel Crosby  16:41

It’s interesting because we all grow up with these money scripts, right? Like money is the you know, fights about money, the number one cause of divorce in America. You know, we grow up in these families, many, many families, most families, even money is a little short. Even in families where money is plentiful, it takes on a whole new, complicated dimension around… is this all we are good for? And like how do I keep my kids from being spoiled?

You know, I work with people very often who have a whole lot of money. And you think that all this psychology would disappear when you’re relatively flush, but in some ways, it just compounds because it’s like, you know, how do we pass this wealth on to our children without totally spoiling them and ruining them. And so, no matter whether you’re from a poor family or a wealthy family, or anywhere in between, you grew up with these messages around money.  And it really is perceived by the broader culture, it is sort of liquid happiness.

You know, a lot of what we strive for in life, to be accepted, to be loved, to have a community, money is seen as a proxy for this or a shortcut to these things. And so I think on the personal finance front, it requires us to get a little bit you know, psychologically naked. We have to get a little bit honest at self-disclosing and self-reflecting about what does money mean to us? And like, what weird messages did I maybe get from my parents about money? My dad is a financial professional.

And so I grew up talking about money at the dinner table, grew up investing from a very young age. You know, my dad hated debt so much that he wouldn’t let us say the word debt. I grew up in a very religious household where we weren’t allowed to swear, of course, but he said, you know, debt is just another four letter word. And so when I went to buy a home, you know, a couple of years back, you know, well into my 30s, I didn’t have any credit history. And so it actually became problematic for me because I didn’t have any credit history to speak of, you know, I’d always paid for everything with cash.

I didn’t have a credit card, it hurt me. And so you know, it was one of those things where this money script which was well-meaning and well-intentioned, and there was an element of truth to it, actually came back to bite me a little bit. So you know, studying and learning about the world ,getting outside of those money scripts we grew up with is an important part of personal finance.

Robert Leonard  19:03

What other common misconceptions around behavioral finance or just human psychology around money are in the world today?

Daniel Crosby  19:12

I think one of the most common in the you know, we’ll call it the personal finance investing social media world, is sort of one that lacks compassion, which is just a lack of understanding that most families just don’t have any money to invest. You know, there’s a lot of families that are just squeaking by. And the fact that we can even talk about these things or worry about these things is quite a privilege. And so I think the accompanying advice there is the best investment that you can make is in yourself.

You know, the best investment you could ever make is in your education, your skills, your connections, because it’s only as you earn money that you have any money to invest or save because for the majority, even of American families, even in the richest country on Earth, more than half of Americans are not saving any appreciable amount of money. So that’s the place to start.

Another one that’s really pervasive is you know what we’ll call it a latte factor, which is this idea that, you know, you need to be cutting out coffee or whatever. And I mean, that stuff certainly adds up. But the thing to worry about first is the big rocks. You know, most people who have really burdensome debt, it’s from college, cars, and homes. If you can keep your house in check. You know, if you can drive a car that gets you from point A to point B, and if you can go you know, to a junior college for a couple of years or not go to that out-of-state college, keep those college costs in check, you’re going to be a long way towards financial success because it takes a lot of lattes to afford four or five years in out-of-state schools.

Robert Leonard  20:45

Yeah, that last one is so interesting to me and I think *inaudible safety was the first one that brought it to my attention and since then Scott Trench from BiggerPockets as well, but they both talked about that idea of your housing and your cars is a lot of money. If your car is $300 and your lattes $3 a day, it takes a lot of lattes to replace that cars or your mortgage or whatever it is. So definitely, you got to look at those bigger things before you start worrying about something as small as a latte.

Daniel Crosby  21:09

Well, I mean, I used to work at a private school where the tuition was about $55,000 a year, you know, to say nothing of living expenses required to live in a, you know, major American city. You know, call it 10 or 15 grand conservatively for living expenses, and you’re staring down a $300,000 bill, after you graduate with your bachelor’s in Renaissance jewelry studies or whatever. So I mean, it’s very, it’s very, very tricky. So those things are big. And then unfortunately, when we’re considering them, our brains aren’t even fully formed, you know, when folks are making these decisions about whether or not to get a credit card in college or what major to study or what school to go to. I mean, scientists now know that your prefrontal cortex isn’t even all there yet. And so we’re making big decisions about our financial future with sort of a cognitive deficit. So it’s a tricky thing that I have a lot of empathy for.

Robert Leonard  22:02

Yeah, it’s interesting too, because a lot of times from people I’ve talked to and just experiences I’ve had, people often feel worse, spending that $3 a day or even a couple times a week on a coffee than they do at first when they spend college. If they’re in college, they’re not even really realizing, you know, they don’t feel bad about spending that $55,000 a year. Whereas if money starts to get a little tight, and they’re still buying their lattes, they start to feel bad about that. So it’s a really interesting dynamic that’s played with human psychology.

Daniel Crosby  22:29

You know, it’s back to this concept of salience that I touched on earlier. That lattes are very salient, right? It feels like a splurge, you do it, you know, anywhere from daily to periodically, but it feels like a splurge. It’s advertised as a splurge. My wife and I talked about this all the time, because she’s the more frugal of the two of us. And she’ll say things like, “Oh, you know, we shouldn’t go out to eat so much. We should not go to so many vacations. Let’s not go out to eat so much.”

And you know, I’ll kind of show her the math and say, “Look if we really want to save money, the thing that we should do is move to Tennessee or Florida.” We live in Atlanta, and there’s no state income tax, you know, one state north and one state south, there’s no income tax. That would save us an order of magnitude more money than cutting out, you know, an out to eat once a week.

And so some of these things can feel like a big splurge, when in reality, they’re not that big of a deal. But things like you know, your geography is huge. You know, your geography is huge from a cost of living standpoint, from a taxation standpoint, and some things like that, which may not be as immediately salient, people would be really wise to think about the tax profile of the state they choose to live in, or you know, the cost of housing in their metro and, you know, go live in Iowa and get Starbucks every day and be happy as a clam.

Robert Leonard  23:48

Those two are such good examples because if you were to move from Atlanta to a state that had no income tax, and you were in a city that you liked, you had friends and family around just like you do in Atlanta, ultimately, you’re probably going to be just as happy in Atlanta as you are in your new city. So your happiness and your overall well-being isn’t changing much. But if you go and cut all of your vacations, that’s something you really enjoy. And by cutting those you might be able to save some money, but you’re not going to be as happy.

Daniel Crosby  24:17

It brings up a great point about how to spend money for happiness too. And there’s great research on this. You know, the research tells us if you want to buy happiness, there’s a couple of ways you can do it. You can spend time with people you love so you know going on that vacation, buy your way out of things you don’t love. So you know getting someone to mow your lawn or clean your house or cook dinner, you know, go out to eat, that’s another way. And then you can spend it on other people you know, you can give generously to charity, you can treat your friends to something so like that’s about it.

Robert Leonard  24:49

So going back to the misconception idea a little bit but tweaking it slightly. What investing advice do you hear given by experts that you think is inaccurate and sometimes makes you shake your head a little and what do you think is the actual truth?

Daniel Crosby  25:01

Okay, so I will tread lightly here lest I anger an army of Bogleheads. So first of all, I’m a big fan of passive investing, right? So passive investing is great. I do a bit of passive and a bit of active personally, that’s a longer conversation. But passive investing is great. But I think the enthusiasm of the personal finance community for passive investing and the recent 10 year fantastic market that we’ve had, I think that people have lost their sense of what risk is, you know? I think people have lost their sense of what can happen.

This idea that I read is like, just buy index funds because they always go up. And that has historically been true over the very long term, you know, over 20 or 30 years, but most people can’t stomach the ride that comes with that. So it’s a little bit of a subtle thing, but I just think the average investor has lost his or her sense of how dangerous markets can be. If you look at the history of investing, the average *entry year drawdown, over the past 30 or so years, has been about 14% a year. We lose double digits just about every year.

At some point in the year, usually that comes back. But every single developed market in the world has had you know drawdowns of 75% plus, including the US. And so markets can get enormously, enormously choppy, even if you’re well-diversified, even if you’re doing smart things like diversifying and managing fees.  So I think it makes the case for broad diversification within and between asset classes, absolutely manage those fees, absolutely get international exposure. And just remember that the reason that markets pay so well is because they have tended to be very, very choppy. The reason that stock markets pay off nicely is because there’s an insecurity premium that comes with all that volatility. You know, don’t let the fact that we haven’t had it recently blind you to the fact that it really is probably likely to be there in the medium to long term future.

Robert Leonard  27:10

I love that point. And I think it’s hard for us to just talk about and for people to really conceptualize, because like you said, over the last 10 years, it’s just been a bull market. And a lot of people listening to the show, and even a lot of people in the financial independence *retire early community that are really into personal finance have probably retired in the last 10 years. And so all they’ve had is a bull market. They might not even have invested in 2007-2008 when things really go against you. So you gotta remember, like you said that things don’t always go up. And it’s going to be really interesting for how people react when things start to go against them, like they did 10 years ago.

Daniel Crosby  27:45

I think the general thrust of the FIRE community is so positive, you know, learning to save, learning to invest, learning to live with less, you know, learning to assume, sort of wanting consumerism, all that is really positive stuff. But I do get concerned when I read these articles of, you know, speaking to the very same thing that I’m talking about. It’s like, “Hey, you know, this person retired, you know, they saved half a million bucks, now they retired and they’re going to live off the 4% rule, they’re going to live off 4% a year.”

And that 500,000 bucks could very quickly become 250,000 bucks, if you’re not careful. And you’ve got to be aggressive enough, if you’re going to retire early, you got to be aggressive enough that you can keep up your purchasing power. And doing that means taking a measure of risk. So you know, by all means, you know, work hard, save, invest, manage those fees, brush off consumerism, but just be a market historian and know that things can get really, really choppy, and be humble about that as well.

Robert Leonard  28:46

Yeah, I love the community and the overall mission of that incentive in general as well. But it’s so tough for somebody to conceptualize that without actually being through it. We can say you know, that you’re going to have to see your portfolio go to 250, but you’re not going to really know what that’s going to be like, until you actually log into your account one day, and you’ve seen over the last three months that your account got cut in half. That’s a whole another psychology test that you have to go through.

Daniel Crosby  29:11

Man, I can’t do it. Godspeed if you can. I know myself, I would freak out before I got to 250. So that’s tough. That’s what derisking assets are for, right?

Robert Leonard  29:21

And that’s why you have a financial advisor, right?

Daniel Crosby  29:23

That’s right. That’s why I have a financial advisor.

Robert Leonard  29:26

So if you were to summarize everything you’ve learned over the years into just one actionable piece of advice, what advice would you give to a millennial listening to the show today?

Daniel Crosby  29:36

The one thing you know, I’ve written three books on behavioral finance, and that really, sadly, can all be summed up by the word automate. So this works on multiple fronts, right? We know that automating withdrawals and automating the process of escalating your contribution over time leads people on average to save much more. So we know that automation helps with the saving and escalation process. But automation also really helps with investing. Automating what you hold, the type of things you hold when you rebalance, when you buy and when you sell.

In my book, The Laws of Wealth, I looked at 200 studies, it was a meta analysis of all the studies that have been done on basically free will like discretionary decision making versus just following simple rules. And it found that 94% of the time following the rules, meets or exceeds the outcome of making a decision just in the heat of a moment. Set them in stone and then just go do more important stuff like you know, this money stuff. This investing stuff is a means to an end. It’s not the end itself. So automate your investing life and then you know, go write the great American novel, go to the beach, do something fun. This stuff is only a means to an end.

Robert Leonard  30:52

If you get so busy having fun, then you don’t think about your money and then you don’t have a chance to mess it up.

Daniel Crosby  30:57

There you go.

Robert Leonard  30:59

Thank you so much for your time, Danie. I really appreciate it. Where can the audience go to learn more about you?

Daniel Crosby  31:04

Yeah, I hope they’ll check out my books, The Laws of Wealth and tThe Behavioral Investor. You can find me on Twitter, @DanielCrosby.

Robert Leonard  31:12

And I’ll be sure to put links to Daniel’s books, and his Twitter, and social media in the show notes so you guys can check it out. Daniel, thanks again.

Daniel Crosby  31:21

My pleasure.

Robert Leonard  31:22

This has been another episode of Millennial Investing. If you enjoyed this episode, you can really help the show grow by taking just 30 seconds to leave a five star rating and review in Apple Podcasts. This really helps more people discover the show and allows me to continue to bring on the absolute best guests for you all. I greatly appreciate the support, and I look forward to seeing you again next week.

Outro  31:44

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