The Behavioral Investor with Dr. Daniel Crosby
Dr. Daniel Crosby, New York Times best selling author, joins Tim Ulbrich to discuss his most recent work The Behavioral Investor. As both a psychologist and asset manager, Dr. Crosby provides a fascinating look into the sociological, neurological and psychological factors that influence our investment decisions and provides solutions for how to improve our behavior to be more likely to succeed with our long-term investing plan.
About Today’s Guest
Educated at Brigham Young and Emory Universities, Dr. Daniel Crosby is a psychologist and behavioral finance expert who helps organizations understand the intersection of mind and markets. Dr. Crosby co-authored a New York Times Best-Selling book titled Personal Benchmark: Integrating Behavioral Finance and Investment Management and is the author of The Laws of Wealth. His most recent work is The Behavioral Investor.
He also constructed the “Irrationality Index,” a sentiment measure that gauges greed and fear in the marketplace from month to month. His ideas have appeared in the Huffington Post and Risk Management Magazine, as well as his monthly columns for WealthManagement.com and Investment News. Daniel was named one of the “12 Thinkers to Watch” by Monster.com and a “Financial Blogger You Should Be Reading” by AARP. When he is not consulting around market psychology, Daniel enjoys independent films, fanatically following St. Louis Cardinals baseball, and spending time with his wife and two children.
Summary
Dr. Daniel Crosby was ready to fully walk in the footsteps of his father and become a financial advisor. During a two year mission trip with his church during college, Daniel became fascinated with human behavior and decided he wanted to study psychology. Toward the end of his doctorate program, he was burned out on clinical psychology work and didn’t know if he was able to do that work full-time. He got a job assessing bankers before they were hired and his passion for behavioral finance was born.
Daniel shares that his new book, The Behavioral Investor, is written more for professionals where The Laws of Wealth is intended more for a mass audience. At conference Daniel attended, he heard people repeatedly sharing ideas that weren’t founded in science. This drove him to research behavioral finance to determine what was true and what he believed.
In this episode, Daniel discusses several aspects of behavioral finance and the research behind them. For example, Daniel shares that research shows that intelligent people can’t avoid behavioral bias. He says that we’re just smart enough to present a credible case to ourselves and that there is a negative correlation between intellect and the ability to navigate financial decisions.
Dr. Crosby also discusses why he has a financial advisor manage his money. He says that even though he likely knows more about markets than his advisor, his biggest impediment to managing his own money is that he gets anxious and freaks out. Having an advisor puts someone else in control and pushes him out of the way.
Mentioned on the Show
- APhA – Use coupon code A19YFP for 20% off your membership!
- Personal Benchmark: Integrating Behavioral Finance and Investment Management by Daniel Crosby and Charles Widger
- The Laws of Wealth: Psychology and the Secret to Investing Success by Daniel Crosby
- The Behavioral Investor by Daniel Crosby
- YFP 057: The Power of Automating Your Financial Plan
- I Will Teach You to be Rich by Ramit Sethi
- Standard Deviations Podcast
- Daniel Crosby on Twitter @danielcrosby
- Daniel Crosby on LinkedIn Daniel Crosby, Ph.D.
- YFP’s Financial Education with APhA
- Your Financial Pharmacist
Episode Transcript
Tim Ulbrich: Hey, what’s up, everybody? Welcome to this week’s episode of the Your Financial Pharmacist podcast. We have a special guest for you, New York Times and USA Today bestselling author, Dr. Daniel Crosby. He was educated at Brigham Young and Emory universities as a psychologist, behavioral finance expert, and asset manager, who applies his study of market psychology to everything from financial product design to security selection. He’s the coauthor of the New York Times bestseller, “Personal Benchmark: Integrating behavioral finance in investment management,” “The Laws of Wealth” — one of my personal favorites — and his most recent work, which we will discuss on today’s show, “The Behavioral Investor.” He is the Chief Behavior Officer and Brinker Capital. His ideas have appeared in the Huffington Post and Risk Management magazine as well as his monthly column for WealthManagement.com and Investment News. He was named one of the ‘12 Thinkers to Watch’ by Monster.com, ‘A Financial Blogger You Should Be Reading’ by AARP, and named the ‘Top 40 Under 40’ by Investment News. When he’s not consulting around market psychology, he enjoys independent films, fanatically following the St. Louis Cardinals baseball team, and spending time with his wife and three children. Daniel, welcome to the show.
Daniel Crosby: Thank you. Great to be here.
Tim Ulbrich: On the Your Financial Pharmacist podcast, we preach the importance of behavior when it comes to managing money, and your work in “The Behavioral Investor,” “The Laws of Wealth,” and your other work so eloquently includes rich research, stories, case studies and cultural references that we can all relate to that make a topic interesting and applicable that, let’s be honest, has a tendency to be quite dry. So before we get into the weeds and talk about behavioral investing, before we get into the nerdy financial conversation, I need to know, how did you find yourself at the crossroads of psychology and personal finance? How does one get interested and make a career of this?
Daniel Crosby: Well, it’s interesting because I entered college, my dad is still a financial advisor, and so I entered college with probably a limited range of options just sort of parroting what my dad had done. And I said, ‘Oh, well, I’m going to be a financial advisor like my dad,’ just saw that that was a good life and indeed it is good work and a good life. But then after my first year of college, I went on a two-year mission for my church and there, I got a chance to interact with people, I got to do a lot of service and things of that nature and just became fascinated by the human condition, the human struggle and sort of came back with this added emphasis on psychology. And I said, ‘Nope, this is what I want to do now. I want to study psychology.’ Well, I finished my bachelor’s, began my PhD three days after I finished my bachelor’s. So it was the ripe old age of 23 when I started my PhD. And towards the end of my PhD program, I was candidly just burning out on doing clinical work because my PhD is in clinical psychology. And so I said, ‘Look, I love psychology, I love thinking deeply about why people do the things that they do, but I don’t know that I’m cut out for 45 hours a week of hearing about people’s most tragic life events and their hardest days.’ And so long story short, found my way back to this original love of finance and got a job out of college assessing bankers pre-hire. So before a bank would hire an executive, they’d bring me in to give them an IQ test and a personality test. And there in the bank, I sort of discovered behavioral economics and behavioral finance in earnest.
Tim Ulbrich: So at the very beginning of the book, Daniel, you mention that the aim of writing this book is to be the most comprehensive guide to the psychology of asset management that’s ever been written. And I think you did a fantastic job of that, but as I read “The Laws of Wealth,” I really enjoyed that work. What inspired you to build upon that that you felt the need to come out with additional research and work that you have here in “The Behavioral Investor?”
Daniel Crosby: Well, you know, for me, it was really two things. “The Laws of Wealth is written more for a mass audience, a retail audience, mom and pop investors. “The Behavioral Investor” is probably better suited for professionals or people with a little bit of background. So there was a bit of an audience shift. But a secondary and perhaps tertiary consideration were I would find myself at conferences with other professionals, other people who were in this kind of world of emotion and finance, and I would hear them sharing ideas that I didn’t think were founded in science, that didn’t sound quite right to me. So there was one conference in particular where I was just sort of frustrated with what was being shared. And I felt like it wasn’t quite right but that I didn’t have the resources at my disposal to rebut what was being said. And so basically, a lot of it was just for me to figure out what I believed. You have a duty — if you’re going to make your living by going around and talking about these things to people, I feel like you have a duty and a responsibility to be better versed than anyone else in these sort of things, and so a lot of the reason why I write is simply to figure out what I believe myself and to teach myself what to think and what to share with others.
Tim Ulbrich: And I think so much of personal finance can quickly become opinion or OK, what did my friend do or what did somebody else or what are others doing? What’s out there in the news? And I think for pharmacists, we are trained, it’s drilled into us to think about evidence-based medicine, and I like so much of what you’ve done here in presenting the research and really putting I think a lot of rigor in depth behind some of the financial principles that will be sound in terms of helping one’s financial plan. So you break the book into four parts, and in part one, you investigate the sociological and neurological and physiological barriers to making sound investment decision-making. And early on in the book, you state, “Humans who are capable of much greater complexity of thought are accordingly capable of much greater self-deception and irrationality.” And you go on to say that there are social norms that define us and that “trusting in commonness and what makes one human but learning not to is what will make you a successful investor.” Tell us more by what you mean by this.
Daniel Crosby: Yeah, so starting with that first point, you know, when we become aware of our tendency to be biased or our tendency to make cognitive errors, a lot of folks and perhaps maybe smart folks like the ones that listen to this podcast go, ‘Oh, well, that pertains to other people but not me because I’m a pharmacist, I’m a doctor, and this is sort of a Joe Six-Pack problem, but it’s not my problem because I’m smarter, I’m better.’ But the research actually shows that there’s a negative correlation between intellect and your ability to successfully navigate some of these things because oftentimes, we’re just smart enough to fool ourselves. Like we’re just smart enough to present a credible case to ourselves that what we’re doing is not, in fact, wrongheaded or biased. And so there’s a couple of things at play: One is that smarts can actually be your own worst enemy in the way that I’ve just said. But in “The Laws of Wealth,” I cited research that shows that people lose 13% of their IQ, basically their cognitive processing power, when they’re in a period of financial stress. And so even for parts of navigating your financial life where smarts are of us, we have least access to them when we actually need them most. So it’s sort of a double-edged sword, but you can’t really think your way out of this one. And it’s a case of what got you there won’t get you to where you want to go. And a lot of people misapply their smarts in this area.
Tim Ulbrich: And I think that makes so much sense. I think any of us can think back to personal financial decisions we’ve made and I think especially as you reflect back — I mean, sometimes in the moment but I think more so reflecting back — where you look at a decision you made and it’s like, what was I thinking? You know, in that moment of time, what was going on? And I think it really speaks to the power of the emotions that can take over some rational thought and as we’ll talk about later in the show, the power of having a plan and putting that plan on automation to really help yourself get out of the way to ensure that your plan can see through to success. Daniel, one of the things I really took away from your book is that while it may seem counterintuitive, you mention that a large body of research suggests that investors profit most when they do the least, you know, really building on what we had just talked about here a couple moments ago. So my question here is, why do we have a tendency towards action? And why can this tendency hurt us when it comes to investing and saving for things like the future in terms of retirement?
Daniel Crosby: Well, one of the hallmarks, one of the key takeaways of “Behavioral Investor” is this idea that things that have served us well evolutionarily or things that have served us well in other parts of our lives serve us poorly when it comes to the investing domain, in particular. And so this action bias, as it’s called, is a great example of this. You know, in many parts of your life, quite intuitively more action does lead to greater results. You know, if you want to get more fit, then you should lift more weights. If you want to get smarter, you should read more books. Taking action does indeed bring about results. But in financial markets, the reverse tends to be true. Myers Statten looked at 19 different countries and found that in every single country that he studied, the more active people were in markets, the more they traded, effectively, the worse they did. And that was a monotonic stepwise relationship. For every extra action you took, you did slightly worse both net of and gross of fees, and so it’s a weird thing to think just about anywhere else, if you want more good stuff, you should do more. But in this world, doing less tends to get you more.
Tim Ulbrich: Yeah, and I think we’ll talk more about automation as well, but I think this really gets to the point of when you can be aware of the potential negative effects of having an action bias or action type of mindset, I think there’s a tendency when it comes to our investments, our finances, to be wanting to check accounts. And certainly if those are reading the news or getting additional information, make quick decisions. And really, again, automation, take a step back, have a plan, have a coach, and really looking at putting that plan on automatic to get yourself out of the way. One of the things that I left with was in Chapter 2, which was titled “Investing on the Brain,” you summarize this study where the brain activity of individuals was measured, and they were making a series of choices that were either immediate or delayed monetary rewards. And I found this part really interesting and so applicable to how we handle our long-term investing strategy, this idea between rewards that are immediate or rewards that are delayed into the future. Can you talk more about what researchers found in this work and what the implications are when it comes to investing, especially investing for the long term?
Daniel Crosby: So what the study found was that when people were presented with a short-term reward, there was a flood of dopamine, which is sort of a neurological reward, if you will, but that no such dopamine rush was present when it was a longer term reward setup. So the key psychological concept here is salience, right? It’s how real, how vivid, how present to the mind, that reward seems. And so research has shown that when people are making long-term plans, what they have to do is make the long-term more salient. So to explain, like what’s happening to me right now is enormously salient because, you know, if I eat a donut or if I go on a walk or do any other pleasurable thing, I’m rewarded in real time. But something like saving for 80-year-old Daniel’s retirement is much more abstract, much more ethereal, much less salient. And so what we have to do is make the future seem more real. And so you see this in studies where people have actually aged their faces, there have been studies where people have shown you what you might look like when you’re 80 years old, and then ask you, do you want to save money now for retirement? And people save at a bigger rate when they imagine themselves vividly older than they are today. So with your planner, with your spouse, with whoever, we need to be having conversations about the future that make that future — if not just as real, much more real than it currently is because that’s going to entice us to do the sort of saving and preparing that we need to do.
Tim Ulbrich: And I think in your example in the book, I think long-term retirement savings, if we think about a traditional retirement model, you work for 40 years, you’re 70, 75, 80, whatever, you know, I think that one’s probably the most obvious in terms of OK, that’s so far off, and I have all these needs that are here today of which — and expenses that can happen, of course. But if I go to spend money today on a vacation or spend money on a home today or spend money on a car today, that’s an immediate reward. And that’s what you talked about in terms of the dopamine pathway being activated versus Tim or Daniel, 40 years from now, it’s a much harder goal to really see the urgency around. So I think that’s an obvious one. You know, one that I’ve personally experienced that maybe isn’t as obvious in a little bit shorter term is even something like savings for kids’ college. So I have four boys, my oldest is 8. And I can remember, I mean, it seems like just yesterday he was a newborn and we were talking about savings for college. And here we are at 8 and lots of needs have really been put ahead of saving for college for a variety of reasons. So while that isn’t necessarily a 40- or 50-year trajectory, it’s more of an 18-year trajectory, I still that gets to the point that you made well in the book of needs that you have today and really being able to work with a coach and a planner to help take those future needs and really making them as real as possible today to prioritize the savings for those. One of the concepts — and you link this well to the idea of keeping up with the Joneses — is you talk in this section of the book that we just referenced, “Investing on the Brain,” about anticipating a reward is deeply satisfying, whereas literally receiving the reward is far less gratifying. And I want to say that again because I think that’s a really interesting concept. “Anticipating a reward is deeply satisfying whereas literally receiving the reward is far less gratifying.” And again, you go on to make the connection here of how we easily can feel dissatisfied in the work and the money that we earn, how you kind of keep pushing that forward and that obviously leads to the concept of keeping up with the Joneses, feeling like you need more and more and more and it’s never enough. So my question here, Daniel, is is there a point where there is enough? How much is enough? And can money buy happiness? Is there a point where wealth can really produce happiness? That’s a question we all often hear and think about.
Daniel Crosby: Yeah, so I wanted to talk about why anticipation is more pleasant than the reward itself, and then I’ll move onto the happiness question. So there’s something in psychology called “focalism,” which is when we imagine a future event, we imagine sort of one dimension of it. We focus on one particular thing. And so if you’re imagining a trip to Hawaii, you focus on laying on the beach with a pina colada in your hand and not getting up at 4 o’clock to make your flight and getting stuck in traffic and everything that it takes to get there because even for something immensely pleasurable, there’s still some element of hassle and negativity associated with it. And we tend not to focus on that. So that is part of why preparing for an event, a vacation, a gift, whatever, is more pleasurable than the event itself. You know, I think about we bought our dream home a couple of years ago. And you know, looking on Zillow and dreaming about all the things we would do there and everything was a lot of fun, but cleaning all of the toilets in a big house is a lot less fun. And so this focalism leads us to sort of one-dimensional appraisals of things, and that is the way that it is. In terms of the literature on money and happiness, it’s really quite fascinating. So in a phrase, money is better at buying the absence of misery than it is at buying happiness. So money can make you not sad. Like people with adequate resources are happier or less sad than people with inadequate resources, and that increases exponentially up to about $75,000 or $80,000, up to about sort of a middle-class income. But after that, it plateaus very quickly because what money is good at doing is having you not worry about living in a safe neighborhood, not worrying about keeping shoes on your kids’ feet, not worrying about keeping food on the table. But once you’ve sort of provided for that lowest rung of Maslow’s Pyramid there, it gets much trickier after that. And after that point, money can buy happiness if you spend it on certain things. And so the things that money can buy happiness is if you spend it on time with others, like a vacation or time with others, if you give it away, so if you’re charitable, and if you buy yourself out of things that you hate doing. So like getting a maid or getting someone to cut your yard or whatever you hate doing, if you can buy your way out of that. And that’s about it. So it provides sort of a worry-free baseline. And then after that, you have to get kind of particular about how you spend it because if you’re not spending it on time with people you love and if you’re not spending it on making your life a little easier, it just doesn’t do much, candidly.
Tim Ulbrich: That’s so rich. And I love how in the book, you talk about the concept, along with keeping up with the Joneses and eventually getting to this basic level of happiness which money can buy of being able to cover needs. You talk about the concept of living on the hedonic treadmill. And I think we can all relate to that where we buy something, and the anticipation of it was much greater than the reality of that or that feeling, that dopamine rush over time subsides. But when we think about investing in things like giving to others and being philanthropic or investing in convenience is what I just heard you say there, investing in time and experiences, I mean, those are the things that really produce that true joy and happiness. And I think that’s such rich information that we all can think about and reflect upon with our own financial plans. Beyond the minimum, beyond taking care of our needs, are we spending our money and investing our money in the things that matter most? Which the literature supports really does buy happiness and hopefully doing what we can to minimize buying things that we know will not produce that same level of happiness. So shifting focus here for a minute, I want to talk about loss aversion because I think that is real for so many listening to this podcast, especially myself, and thinking of those that were significantly impacted, either directly or indirectly, by the 2008 recession. Can you talk further about the concept of loss aversion and how this may have an impact on one’s long-term savings plan?
Daniel Crosby: Yeah, so loss aversion is the observation in the psychological literature that people are about 2.5 times as upset about a loss as they are excited about a comparably sized gain. So if you go to Vegas, and you lose $100, you’re upset. If you gain $100 bucks, you’re like, yeah, whatever, it doesn’t change my life. So this is sort of this asymmetrical relationship we have between how we perceive loss and gain. So of course, this leads people to do a number of things in markets, notably, to take too little risk. Now this can be exacerbated, depending on sort of where in your life you encountered the markets. So for me, I just turned 40 last week, and so I got out of school in 2008, I finished my PhD in 2008. And so the first thing I did is I got out of school, I got a job, started saving, started investing, and immediately ran into the buzzsaw of 2008 and early 2009. And so there’s something in psychology called this primacy and recency effect. So we have increased memory, right, we hang onto things that happen early in a sequence or late in a sequence. And so for people like me whose initial foray into investing was getting their money chewed up and spat out, it can be a very discouraging thing.
Tim Ulbrich: And I think, Daniel, so I’m on the exact opposite. I also finished my pharmacy degree in 2008, but I was doing residency in 2009, so when I just started investing, I’ve only been on the other side of this 10-year run in the positive. So I have yet to experience that loss. I really bought at probably about the lowest point, and so I think that leads me to be somewhat of overconfident in what the markets will do. And I think you do a good job in the book of when you’re thinking about risk, truly assessing risk not based on one experience or one moment in time but really looking at the historical risk. And I think on the other side of that when I think of my experience is that I shouldn’t necessarily look at this 10-year period, as I may have a tendency to do, and expect that that run is going to continue going forward. And so I think there’s — I could see this on both sides of it as well. And I hope our listeners will pick up a copy of the book because in “The Behavioral Investor,” you do a great job — and we’re only talking about a few of them here, obviously loss aversion being one — but you do a great job of distilling what you say is more than 117 different types of behavioral biases into four types of behavioral risk: ego, conservatism, attention, and emotion. And you walk through each one of those in detail, you give strategies to overcome, and so I hope our readers will get the book to look at more of those in detail. So I want to shift to the topic of automation. And I think — and you mention in the book — you could have really titled the book and distilled it down to three words: automation, automation, automation. And I find the irony in your book of there’s so much complex research and so much rich data and ultimately, it gets to this concept of less is more, automation, and have a coach. And so talk to us about the power of automation and how that helps combat some of these biases. And I’d also be interested in, you know, how have you successfully navigated automation, even in your own financial plan?
Daniel Crosby: Yeah, it’s a fascinating thing because people make the mistake of thinking that a complex, dynamic system like the stock market has to be met or solved with equal complexity. And you remember from your stats class that to avoid overfitting, when something is complex and dynamic and always in flux, really the way to not overfit by solving that problem is to approach it quite simply and with just a couple of rules. And you know, you’ve touched on a couple of mine, which are automate and work with a coach. And so automation is great because it actually takes a human tendency to be prone to the status quo, to be sort of lazy, and it locks it in for our benefit. So you know, being lazy can lead you to never start saving and investing, and that’s certainly problematic. But if you begin a robust program of investing and saving, and then you lock that in and you automate it, that same laziness can work to your benefit. So that’s sort of the magic of automation is it just locks in this human tendency to be conservative and be status quo-prone and uses it, flips it on its head and uses it for our benefit. The second piece I’ve written about quite a bit is that I work with a coach, like I pay a financial advisor. And I mean, at the risk of being arrogant here, I probably know more about financial markets than my financial advisor. And so why do I pay someone to manage my money, to hang onto my money when I perhaps know more than they do on paper? Well, the reason goes back to our conversation about education and IQ and these sorts of things. The biggest impediment to me reaching my financial goals is not inadequate knowledge of markets. The biggest impediment is me freaking out.
Tim Ulbrich: Yes.
Daniel Crosby: And so I understand that I’m no different than the next person. Like I can’t write enough books to make myself rational or calm or cool-headed. And I know myself. And I’m, in fact, quite not level-headed. I’m quite anxious, and I’m quite skittish. And markets — and look, let’s call it what it is, just in life general, nobody goes into psychology because they’re well-adjusted, right?
Tim Ulbrich: Right, right.
Daniel Crosby: So I know this about myself, and I build a wall to keep me out of my own way.
Tim Ulbrich: Yeah, and I think the self-awareness — I share that with you as well — I think the self-awareness of that and then taking the initiative to say, OK, I need that coach, I need that accountability, because I think as your book highlights so well, we’re just hardwired toward getting in our own way when it comes to being successful with investments. And so I think if we can acknowledge that, be aware of that, call it what it is, I think that really gives us the humility to say, OK, we probably need somebody in our corner to help us out with this plan. I would also point our listeners to, in addition to Daniel’s book, we talked about automation in detail on Episode 057 of the podcast if you want to check that out. And a book I’ve talked about before on this show is “I Will Teach You to Be Rich” by Rahmit Sedi. I think he does a really, really nice job of talking about the power of automation and giving some examples of what that could look like. And in his plan, he talks a lot about that upfront time investment to develop the plan or work with a coach to do that. But then after that, you’re really saving yourself time and I would argue saving yourself a lot of anxiety and stress when you know that you’re going to be really just overseeing the plan as it’s hopefully functioning and running itself and not having to really wonder, am I achieving this? Am I not achieving this? What’s going on with certain parts of the plan? I want to end by talking about passive investing versus active investing, two terms that many of our listeners are probably familiar with. But then a third approach that you talk about, which is a new approach called rule-based behavioral investing and why that may be even a better approach than passive investing, which I think many of our listeners would probably be in favor of. So can you briefly define passive and active for those that are not familiar with those terms when it comes to investing? And then outline what’s different about rule-based behavioral investing?
Daniel Crosby: Yeah, so passive investing in its purest form is saying, I don’t know what the market’s going to do in the future. So I’m going to own the entire market, effectively, to use the S&P 500 as a proxy for the entire market. Instead of trying to pick the winners and losers from these 500 largest companies in the U.S. economy, I’m just going to own them all and own them in the sizes that they are. So the bigger the company, the bigger a piece of my portfolio it will be. And I’m not going to try and pick winners and losers. Active investing would be trying to pick winners and losers from among those 500, again, just using this as a simplified proxy, we’re going to try and pick the top 50 stocks from among these 500, hold those 50 with the aim of beating that benchmark, as it were. And so like many things I think in our day and age, the conversation around active and passive I think has sort of devolved into hysterics and people just shouting at each other from the other side, the other bank of the river. And so I wanted to look at this and say, ‘You know, what works about passive investing? And what works with active investing? And let’s just do that. Like let’s just do what works.’ So when I looked at what works, it must be said that the reason there are so many passive enthusiasts is that it’s just worked very well and it’s very cheap, on average. So if you look at 10-year periods over the last 10 years, it’s something like 85% of passive vehicles have beaten their active brethren and at a fraction of the cost, so that’s very compelling stuff. But passive investing still falls prey to a couple of mistakes. You know one of them that is somewhat controversial is market cap waiting, which basically says the larger a company is, the larger the size of my portfolio it will constitute in a true passive portfolio. Well, there’s research to suggest that larger stocks underperform smaller stocks. So you might want to do something as simple as equal weight or broaden your universe. There’s also interesting research that I think not many people are aware of. If you look at something like the S&P 500, this is the Standard & Poor’s 500. You know, the Standard & Poor’s is a rating agency. This isn’t mined from the earth, right? Like this doesn’t occur in nature. There’s a secret committee of people who chooses who will go into and out of the S&P 500. And at times, they have made poor decisions, just like we all do. They’ve made decisions to include, to break their own rules around profitability to include AOL right before the tech bubble burst. So they can break their own rules, they can make poor, wrong-headed, discretionary choices that can lead to some underperformance. So my thought was take the best parts of passive investing. It’s well diversified, it’s cheap, and do those things. Never overpay. Diversify to the hilt. Those are great things to learn. But you can also take rules from active investing or the best types of active investing, which is don’t use your discretion. Don’t leave it up to some external force to choose what’s going to go into your portfolio. You rule based on choosing affordably priced, high quality shares, weight them in a way that’s consistent with strong performance historically. So you know, before I get an angry army of passive investing enthusiasts after me, there’s so much recommended. For the average person, for the person who just doesn’t want to think about this stuff, passive investing makes all the sense in the world. But if you’re interested in these things and you want to take it just a step further, I think there are ways that you can improve on market cap-weighted passive investing that are very sensible and very affordable.
Tim Ulbrich: Yeah, and you do a great job of this. Chapter 12 is called “Investing a Third Way,” and I found this very refreshing, to be honest. And confession time to my audience and community, I mean, I was one of those people, I am one of those people I feel like that is kind of on the side of passive investing, shouting across the riverbank to the people on the active side. And I think this was just a good reminder of, you know, as you mentioned, many things in life, it’s not one of two options, but there’s multiple options. And really taking a look to see what’s the best from both of these? And is there a third way and a third approach. And you do a great job in outlining this in a table in terms of what really are the advantages of what you’re referring to here as this rule-based behavioral investing. It’s got low fees, it’s diversified, it has the potential to outperform, obviously potential a key word there, low turnover, and manages bias. And in the book, you were very clear and your quote was, “To be as direct as possible, passive investing should be the de facto choice of those uninterested in the art and science of investment managing. By buying a diversified basket of index funds that covers a variety of asset classes, know nothing investors who often know a great deal are likely to beat more than 90% of active managers and have time to focus on pursuits more meaningful than compounding wealth.” And so I think that’s also a great reminder of again, there’s not one or two options. There’s a multitude of options. And this also depends on how involved and how interested you want to be in learning more about the process. So Daniel, thank you so much for taking time, for coming on the show, for, again, the work that you’ve done here in “The Behavioral Investor,” “The Laws of Wealth,” and the other work that you’ve put out there as well. So in addition to listening to your podcast called “Standard Deviations” and getting ahold of the book, “The Behavioral Investor,” which is available pretty much anywhere, where can our listeners go to learn more about the work that you are doing?
Daniel Crosby: I’m very active on Twitter @danielcrosby and also post a lot of my research on LinkedIn, so just Daniel Crosby, PhD. So thank you so much for having me.
Tim Ulbrich: Awesome. Thank you so much, Daniel.
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