Behavioral Finance Lessons

Recently, I listened to a terrific podcast with Dr. Daniel Crosby, author of a new book, The Laws of Wealth: Psychology and the Secret to Investing Success and co-author of a former New York Times bestseller Personal Benchmark: Integrating Behavioral Finance and Investment Management.

When he was asked for his number one piece of investment advice, he said investors should automate the way they invest. “The apparatus the-laws-of-wealth-bookthat we come to earth with just makes us very poor investors, it makes us emotional and short sighted and greedy and fearful and everything you don’t need to really make the most of investing in capital markets. . . analysis shows that following simple laws or simple rules beats PhD level human discretion, beats or equals it 94% of the time and certainly does so at much lower cost.”

More specifically, Dr. Crosby states “stick to your discipline, dollar-cost average, diversify and ride out the storms.” Dollar-cost averaging, where you invest a pre-set amount on a pre-determined date no matter what the market is doing, is the most effective way to build and maintain wealth. Dollar-cost averaging removes the emotional decision of trying to determine if I should invest now or later.

Many investors obsess over which stock to buy when the better decision is to invest in broadly diversified and low-cost mutual funds that hold numerous stocks. In fact, most of our clients hold a globally diversified portfolio of approximately 12,000 stocks.

And finally, once you establish an appropriate long-term asset allocation plan for your portfolio, stick with it. You should only consider modifying you investment plan when your goals change.

Dr. Crosby was also asked his number one money habit and said “you can’t do this alone. I work with an investment adviser. The reason that I do this is because I understand that I’m just as irrational and stupid and scared and greedy as the next person.”

A trusted advisor can help you to automate your contributions and use what we know about human behavior to your advantage. For example, Dr. Crosby references a study on “goals based investing,” or in other words, what is our motivation. He relates an example from the study about low income savers who were trying everything they could to set aside more money. Motivations included both rewards and punishments. Nothing worked until they were shown a picture of their children. “Before they would make a decision whether to save or spend their money, investors were asked to ruminate on their children and look at a picture of their children. When they did something as simple as that, they saved more than 200% as much as they had been previously.” His conclusion was that “there’s a way to introduce life into this process in a way that makes it less sterile and actually gets you moving in the right direction.”

Dr. Crosby says one reason people have such a hard time saving is because it involves self-depravation for a hoped for future outcome. A trusted advisor can help to identify goals and keep them front and center during inevitable life changes, market gyrations and uncertain times.

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