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Speaker 1: That humans are a species of incredible innovation in art, science, literature.

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Speaker 2: Yet of all the things we're brilliant at, investing isn't

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Speaker 2: one of them. Why, Well, we're easily excited. We get

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Speaker 2: focused on the wrong things, obsessed with what just happened

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Speaker 2: rather than what might happen next. We're bad at understanding maths,

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Speaker 2: and we despise delaying gratification. Top all of this off

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Speaker 2: with unjustified over confidence, and you have a recipe for

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Speaker 2: investing underperformance. As it turns out, when it comes to investing,

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Speaker 2: we're just not built for it. I'm Barry Redults and

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Speaker 2: on today's edition of At the Money, we're going to

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Speaker 2: discuss how to become more systematic and rules based in

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Speaker 2: managing our money. To help us unpack all of this

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Speaker 2: and what it means for your portfolio, let's bring in

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Speaker 2: doctor Daniel Crosby. He's the Chief behavior Officer at Orion,

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Speaker 2: where he develops tools, training, and technology to help financial

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Speaker 2: advisors apply behavioral science in their practice. He is also

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Speaker 2: the author of the book The Laws of Wealth, Psychology

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Speaker 2: and the Secret to Investing Success. So, Daniel, let's start

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Speaker 2: with just a basic idea. Why is a rules based

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Speaker 2: approach to managing money. So important.

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Speaker 3: Yeah, very good to be with you. Well, one reason

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Speaker 3: is because rules work. You know, when we look at

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Speaker 3: a meta analysis, so this is a study of all

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Speaker 3: the studies on how rules fare. Simple rules fare against

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Speaker 3: a PhD level discretionary decision making. Rules match or beat

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Speaker 3: expert level decision making ninety four percent of the time,

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Speaker 3: which is pretty staff. And we see this across context.

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Speaker 3: We see this everywhere from medical diagnosis to stockpicking, to

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Speaker 3: financial planning to prison recidivism studies. That one's one of

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Speaker 3: my favorite. They went from sort of having these soul

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Speaker 3: searching interviews with prisoners to looking at two variables. You know,

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Speaker 3: what are they in for and how did they act

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Speaker 3: while they were in And they increase the efficacy of

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Speaker 3: their judgments by almost four hundred percent. So they work

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Speaker 3: is one reason. And they're cheap is another reason. You know,

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Speaker 3: it's a lot cheaper to set up a checklist or

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Speaker 3: a simple set of rules than to pay a bunch

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Speaker 3: of CFAs to try and get it right. So they work,

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Speaker 3: and they work on a budget.

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Speaker 2: So I love the idea of the checklist because it

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Speaker 2: plays very much into an issue that's a pet peeve.

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Speaker 2: Of mine, which is investors tend to obsess about all

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Speaker 2: these things they cannot control, things that are out of

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Speaker 2: their diction, while ignoring the things that they can control.

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Speaker 2: Talk a little bit about how creating a checklist allows

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Speaker 2: you to focus on things that are within your control.

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Speaker 3: Yeah, very When I wrote the book, you know, the

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Speaker 3: very first chapter, and I was intentional about the ordering.

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Speaker 3: The very first chapter in the book is you control

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Speaker 3: what matters most. Because I found what I think you

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Speaker 3: find when you tell someone you work in markets, that

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Speaker 3: you work in finance, they ask you about one hundred things.

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Speaker 3: All one hundred are outside of their power. What's the

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Speaker 3: FED going to do, what's the virus going to do,

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Speaker 3: what's the war going to do, Who's going to win

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Speaker 3: the election? Stuff that is a almost inevitably unknowable and

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Speaker 3: be outside of their power. So what I think we

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Speaker 3: have to encourage people to do is to take the

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Speaker 3: power back and to frame it that way, because things

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Speaker 3: like fees, things like diversification, choosing to work with a professional,

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Speaker 3: all of these things are within our control and are

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Speaker 3: far more predictive of you crossing your financial finish line

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Speaker 3: than any of that other stuff.

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Speaker 2: There's a great story in Michael Lewis's book about Sam

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Speaker 2: Benkman Free and FTX about Jane Street Trading, and even

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Speaker 2: though they got the twenty sixteen election results correct, they

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Speaker 2: still were unable to anticipate what the market reaction would be.

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Speaker 2: So not only are these things out of your control

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Speaker 2: and they are unknowable, but even when you know it, Hey,

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Speaker 2: what's the reaction of tens of millions of traders going

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Speaker 2: to be? We really have no idea.

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Speaker 3: Yeah, no, it's true, like no one thought Trump would win,

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Speaker 3: and then most folks who thought that he would win

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Speaker 3: thought it would tank the market. Both things were proven wrong.

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Speaker 2: H really amazing. So let's bring this back to the

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Speaker 2: investing decision making process. You emphasize why the process of

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Speaker 2: making good decisions is so much more important than trying

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Speaker 2: to predict market movements.

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Speaker 3: Explain, Yeah, it's really about being the house and not

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Speaker 3: the degenerate gambler.

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Speaker 1: Right.

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Speaker 3: If you look at all the bright lights in Vegas,

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Speaker 3: all that gets paid for by tilting probability in favor

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Speaker 3: of the house. And if you look at a lot

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Speaker 3: of casino games, the edge the house has is not dramatic.

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Speaker 3: I mean, in some cases it's infinitesimly small, but tilting

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Speaker 3: probability in your favor time and time and time again.

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Speaker 3: Showing up doing the things that are within your power

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Speaker 3: time and time again, pays for some nice lights and

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Speaker 3: some nice fountains, as we see in Vegas. So that's

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Speaker 3: all we're trying to do here, control the controllable tilt

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Speaker 3: probability in our favor in a small way. You're not

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Speaker 3: always going to get it right, but you're always going

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Speaker 3: to be at the wheel.

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Speaker 2: So I mentioned in the introduction that we're all filled

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Speaker 2: with so much over confidence. You have a chapter titled

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Speaker 2: You Are Not Special. Tell us about why investors need

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Speaker 2: to stay humble and why we're all subject to the

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Speaker 2: same biases and errors as everybody else.

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Speaker 3: Well, I love this one because I think it demonstrates

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Speaker 3: how psychological biases can serve us. They serve us well

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Speaker 3: in some domains in life. If we look at over

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Speaker 3: confidence bias, it serves us really nicely. In some ways.

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Speaker 3: People who exhibit it are happier, they're more successful, they're

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Speaker 3: more likely to be successful entrepreneurs. God, they're definitely more

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Speaker 3: likely to run for office. Right, There's all of these

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Speaker 3: things that over confidence does, but when you apply it

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Speaker 3: to markets. There's three specific ways that we're over confident.

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Speaker 3: The first is we think we're better than average right, smarter, better, faster, stronger,

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Speaker 3: better at picking stocks, And that's the one that gets

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Speaker 3: the most publicity. But there's actually two others as well.

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Speaker 3: One is we think we're luckier than average. Ask people,

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Speaker 3: you know, what's the likelihood of something happening to you,

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Speaker 3: like getting divorced, and like, effectively, no one says they'll

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Speaker 3: get divorced, even though you know one and two people

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Speaker 3: gets divorced. No one thinks they're going to get cancer

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Speaker 3: or you know, have diabetes, or you know, on and

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Speaker 3: on and on. But if you ask people about their

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Speaker 3: odds of finding love or winning the lottery, they dramatically

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Speaker 3: overrate these probabilities. So we sort of tend to own

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Speaker 3: the optimistic and delegate the dangerous. That's a second sort

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Speaker 3: of facet of overconfidence. And then the third one is

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Speaker 3: we think that we're more prescient about the future than

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Speaker 3: we actually are, Like we think we're better at forecasting

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Speaker 3: what's going to happen. So these three forms of overconfidence

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Speaker 3: are a pretty toxic cocktail of bad decision making. So

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Speaker 3: we really you know, our mutual friend Jim O'Shaughnessy has

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Speaker 3: this great line in his seminal work What Works on

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Speaker 3: Wall Street that I'll butcher here, but it's effectively like, look,

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Speaker 3: rule one. Step one is understanding that you are prone

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Speaker 3: to all of the same screw ups as the next person,

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Speaker 3: and until you sort of deeply internalized that you shouldn't start.

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Speaker 2: Yeah, Jason's why. I guess Danny Khneman what he does

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Speaker 2: to avoid all of the behavioral biases and heuristics that

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Speaker 2: him and Amos Tversky discovered. And his answer was nothing.

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Speaker 2: We can't avoid it. They're just totally unavoidable. Hey, if

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Speaker 2: Danny Connoman can't avoid them, you know what hope did

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Speaker 2: the rest of us have?

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Speaker 3: Yeah?

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Speaker 2: So there's another line I really appreciate, And this perhaps

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Speaker 2: is because I began on a trading desk, and what

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Speaker 2: led me to realize it was time to move on

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Speaker 2: was how much fun I was having, regardless of my

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Speaker 2: p and L. You right, if it's fun, you're probably

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Speaker 2: not making money. I bet a lot of traders can

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Speaker 2: confirm this. Tell us why fun and making money are

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Speaker 2: not necessarily consistent, and what we need to do to

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Speaker 2: be more methodical and more disciplines.

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Speaker 3: Yeah, it's really like one of these harsh truths about

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Speaker 3: I refer to it in the book as Wall Street

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Speaker 3: Bizarro world. How the truths of every day are sort

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Speaker 3: of one eighty to the truths of markets. And one

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Speaker 3: of the things that we find is some of the

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Speaker 3: most exciting, most fun ways to try and make money

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Speaker 3: in the markets are the most deleterious to our wealth.

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Speaker 3: You know, you look at day trading. The most comprehensive

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Speaker 3: study on day trading ever done was out of Taiwan,

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Speaker 3: and they found that one in three hundred and sixty

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Speaker 3: day traders show evidence of skill. So is day trading fun?

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Speaker 1: Like?

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Speaker 3: Absolutely, it's a blast, right, Like making short term trades

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Speaker 3: can be fun, it can be intoxicating, it can be exciting,

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Speaker 3: but you know, the chances of you being good at

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Speaker 3: it are vanishingly small. You look at other stuff like

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Speaker 3: IPO investing. You know, everyone's got this story about if

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Speaker 3: you would you know, if you'd put ten thousand dollars

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Speaker 3: in video or Apple or whatever, you'd be a gazillionaire now.

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Speaker 3: But we know that on average, the average IPO does

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Speaker 3: twenty one percent worse than the s and P five

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Speaker 3: hundred in the first three years. And so again, is

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Speaker 3: IPO investing fun? Yeah? Absolutely, but you are the gambler.

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Speaker 3: You are the gambler and not the house, and you're

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Speaker 3: unlikely to secure that monet if you're engaging in these

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Speaker 3: sorts of fun behaviors.

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Speaker 2: Let's talk about forecasting is for weathermen. Why are we

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Speaker 2: so bad at forecasting? And what should we focus on?

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Speaker 3: Well, it goes back to that. You know, it's one

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Speaker 3: of those primary forms of overconfidence. And the research on

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Speaker 3: this is just wild. You know, Philip Tetlock did sort

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Speaker 3: of the seminal research on political and financial forecasting and

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Speaker 3: found that, you know, even the experts are terrible at this,

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Speaker 3: and in fact, the more famous and expert, the worst

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Speaker 3: they tended to be because you get famous as a

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Speaker 3: market prognosticator is making sort of a once in a

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Speaker 3: lifetime black swan prediction, and then you tend to continue

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Speaker 3: to bang that drum because it worked the first time,

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Speaker 3: and you know, history on average is pretty average, and

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Speaker 3: then you're wrong. But the reason we're always going to

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Speaker 3: look for this is the way that we're wired. Right.

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Speaker 3: Our brains are are two to three percent of our

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Speaker 3: body weight. But they're twenty to twenty five percent of

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Speaker 3: our caloric expenditures in a given day. And so when

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Speaker 3: we look at people again hooked up to an fMRI

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Speaker 3: machine who are watching cable financial news, watching someone make

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Speaker 3: predictions about what's going to happen, the part of their

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Speaker 3: brain associated with critical thinking and decision making actually goes

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Speaker 3: to sleep, which is candidly what we are looking for,

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Speaker 3: right We're looking for that peace of mind. We're looking

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Speaker 3: to think less and go into energy saver mode. So

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Speaker 3: as bad as we are at forecasting, there will always

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Speaker 3: be a market for some sort of certainty. And I

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Speaker 3: think the only thing that we can do is to

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Speaker 3: work with a financial advisor who can give us some

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Speaker 3: sort of certainty around our plan, our purpose, our immediate

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Speaker 3: financial lives, instead of delegating that to some impersonal talking head.

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Speaker 2: So I'm glad you brought up the financial advisor. You

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Speaker 2: discuss how hard it is to do this alone and

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Speaker 2: why you should seek professional advice and support, if for

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Speaker 2: no other reason then to help you manage your biases

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Speaker 2: and your emotions. Discuss your experience with people working with professionals.

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Speaker 3: Yeah, this is one of probably the two most powerful

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Speaker 3: things you can do to manage those behavioral biases that

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Speaker 3: Danny Kneman talked about, right, I mean, he talks, as

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Speaker 3: you said, about the futility of it. I think the

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Speaker 3: two best hopes we have against behavioral bias is automation

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Speaker 3: and working with a professional. The data is very clear

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Speaker 3: now that people who work with the professional tend to

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Speaker 3: do better than those that don't. And when we look

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Speaker 3: at a twenty sixteen Merrill Lynch study, the things that

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Speaker 3: an advisor does for you are all additive. Like they

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Speaker 3: sort of broke this down by the different things that

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Speaker 3: an advisor does in his or her day, everything from

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Speaker 3: you know, security selection to asset allocation to tax alpha.

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Speaker 2: It all helps.

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Speaker 3: But the thing that helps the most is again this

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Speaker 3: behavioral coaching, the emotion management, the guidance around decision making,

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Speaker 3: keeping you from investing in your son in law's dumb business.

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Speaker 3: You know, just these these pivotal points along the way.

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Speaker 3: That's really where it adds about us four times as

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Speaker 3: much value as the other stuff. And what's cool for me,

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Speaker 3: as the son of a financial advisor who works with

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Speaker 3: financial advisors every day, is people who work with an

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Speaker 3: advisor have better marital communications. They have higher levels of

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Speaker 3: aggregate happiness. They're more prepared for an emergent. See like

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Speaker 3: they have all these non financial things in their life

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Speaker 3: that get lifted because money touches everything we do. So

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Speaker 3: if you can get that right, a lot of other

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Speaker 3: boats in your life to start to rise as well.

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Speaker 2: So to wrap up, humans are great at a lot

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Speaker 2: of things, but we also come prepackaged with a lot

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Speaker 2: of evolutionary baggage. We're easily excitable, we make poor decisions,

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Speaker 2: we think we're special, we're wildly overoptimistic, and we tend

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Speaker 2: to overreact to every sign of trouble like it's the

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Speaker 2: end of the world. We're much better off if we

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Speaker 2: have a rules based, systematic approach to managing risk and

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Speaker 2: investing for the future. Rather than making these decisions on

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Speaker 2: the fly to help your portfolio, you really need to

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Speaker 2: think about what is the best result for you over

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Speaker 2: the long haul, not just make making these decisions spur

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Speaker 2: the moment. I'm Barry Rudolts. You're listening to Bloomberg's at

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Speaker 2: the Money

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Speaker 1: Little little that you burnt, that you burn