Fixing Your Broken Financial Behavior w/ Dan Egan #911

it is that easy. And evidently we are the reasons that we don't have more money or whatever it is that we want in life. Here to talk to us today about that is behavioral scientist Dan Dan is the director of Behavioral Finance and Investing over at Betterments, and today we're going to discuss how human psychology impacts our financial decision making. Dan, and thank you so much for taking the time to speak with Joel and I today.

So I have like six pairs of the same sunglasses and ones inside the car and the other ones in my back, et cetera. It costs a bit more, you know, like it feels a little bit unfrugal because you could just have one. But I absolutely love having these extras and spares.

and maybe it is. But yeah, I want, like I was like this, I spend so many hours on these things. I want them to be the same and make me happy.

He'd be like, no, no, no, no, second, I've got the same water bottle at home that I get.

it through the washer. It's still one of my favorite hoodies. It's fantastic. Oh my goes, I can't believe you did that.

in the nineteen seventies. So the paper that won Daniel Konneman and Namedstavirsky the Nobel Prize was published in nineteen seventy four. So it takes a little while for academic findings to get sort of substantiated and brought over to the commercial world. So twenty thirty years isn't that bad. I've been doing this now for about fifteen years in an applied kind of business setting. So I actually remember in college I was doing economics and the most interesting

part of it was the introspective of microeconomics. Why do we make decisions this way? How do we think about risk and return? And can we do it better? There's sort of systematic patterns in how people mismake decisions about what's going to make them happy in the future in

terms of how and when they spend money. And is there like a career there where I get to go and think about, oh, you keep making the same mistake over and over again with money, maybe you could help other people avoid that mistake?

dollars is going to be different. So the first thing, which again is very into it, is just we are not kind of computers that look at how much money will I end up with? We are people who say, here's where I am now, what's the change from where I am now? When we're considering a decision. So number one reference point dependent. Number two, we're risk averse, which is that we generally are going to require there to be a bigger payoff if we're going into a risky situation.

The neat thing that prospect theory found is that while that's true more in the gain setting, it actually flips in losses. We are risk seeking in losses, which this comes up in gambling a lot, where if you are losing, you're gonna be like, I want to double down, I want to get back to even. It comes up in single stock investing a lot where this translates over to something called the disposition effect, where people will sell stocks that have gone up in value because it feels good.

They're closing out again. It feels nice. But people who are holding onto a losing stock will hold on to it for nearly twice as long in the hope that they'll get back to even. And in fact, if they get back to even, they sort of sell out of that stock immediately because they're like, few that sucked, but

at least I didn't lose any money on it. So those three things reference dependence, risk aversion, and gains and risk seeking lawsuits is prospect theory, and it's been incredibly powerful for explaining a wide array of behavior about insurance or gambling behavior, or investor behavior, or what neighborhood we choose to live in, and how to incentivize teachers to improve their students' test scores.

that day. It's easy to identify the biases. But when it comes down to actually like fixing those errors in maybe the way in particular that we approach our personal finances, what does that look like?

We have a lot of like automatic processes that run so that we don't have to think about them. Changing your behavior is tough. So number one, you have to say this is something I want to change. Number two, you have to set up habits or patterns or external prostheses to get you to do those things differently and stick with them over a period of time. So the analogy I like to use is it's very easy to say, like, oh, you're short sighted, you should wear glasses. Making glasses is

really difficult. Remembering your glasses and remembering to wear your glasses is a little bit as much harder. So when we find a behavioral bias, it's nice, but it's sort of like the beginning of the are people going to admit and want to be helped with this thing? Are they going to be able to let go pride in you go and say, yeah, I'm flawed and here's something

that I would like to be better at. And number two, can we set up an environment or tools or accountability patterns that help them actually change that behavioral pattern.

have something happening, right. Like It's funny, like we were just talking about this with bit when it came to bitcoin and investing, because we've seen a run up recently and I was just like, dang it, I feel like this is something I should have addressed because we own a small amount of bitcoin, not much, but I was like, I prior to this most recent run up, I wish I would have created some sort of rule that said that, oh, right, once it hits one hundred k, once it hits two

hundred two and fifty, what am I going to do? Because in the moment once it hits zero or zero, Because then the moment you're thinking, you're either looking to minimize risk, like you said, or you're looking to kind of maximize risk and take on additional risk. Is that what you're talking about here? You're almost talking about rules and systems to put in place.

and if bitcoin does that, I will do that. So you've already set out you're sort of like your policy, your strategy. Now you have to have some way to implement it that doesn't rely on your self control and doing it in the moment. And that's really the hard part. It's easy to say, like I'm going to eat healthy. Here's what I'm gonna eat Monday, Tuesday, Wednesday, Thursday. How are you going to handle it when the snack tray

comes around? Yeah, So that's the process. Processes is the idea of kind of being a bionic person, having external things glasses for example, that help you to in effect see the world or interact with the world in the way that you really want to. So a good example of this that I think it's so illuminating in multiple ways.

There's a study that was done with a German brokerage so like trading brokerage, stock brokerage, online stock brokerage, and what they did is they said, for free, no cost to you, we the researchers are going to send you

performance reports for your accounts every three months. And they did this off the back of some research that found that generally speaking, people don't know what their own portfolio returns are, or if they do, they tend to pay more attention when they believe that they're going to have beaten the market and be up, then underperform the market and or be down. So when we pay attention to

how we've done is very asymmetric. We pay more attention when we think it's going to make us feel good, and so most people don't realize how often and when they have underperformed or done poorly at investing. So these reseachers just said, cool, we want to give people feedback, Like a professional portfolio manager whose job it was to get We're going to give them these performance reports every three months. For I believe it was a year and a half, and it told them, you know, like what

percentage of trades you made did well? Did you beat the index? Did you underperform? Were you overweight in specific sectors. It was very like, at some level like dry stuff, but it was a feedback loop that told them unequivocally, here were your returns, here were the returns of the market over the same period, and here's some other information

about you. And what they found is that at the end of I believe, one year of sending these people reports again just for them over the course of the year every three months these personalized performance reports, people started trading less. They were more likely to use kind of

broad based index funds, they were more diversified. So this was a good signal that like this kind of personalized feedback that tells somebody, hey, maybe you're not so good at this, Maybe you could, you know, spend your time doing other things and it would be a better use

of your time. It works. At the same time, that brokerage after the study was done, was like, cool, let's shut this down because people are trading less, yea, and they're not happy that we're telling them that they're doing it best.

advertising companies, advertising companies, social media companies. There's this way in which you can say, ah, here's what's true about human behavior. Let me exploit this from my own personal benefit. And it sounds like that company maybe was onto something good and then abandon it because they realized maybe it was benefiting investors but not the company itself.

so much better than paying any little amount. But that means that you have a very different relationship with whoever's providing the service, Like if your stock brokerage is free, they're getting paid by somebody else, which means you kind of don't have any like leverage with them to say, here's the service that I want, here's how I would like things to be different, here's how you could improve things for me, and like I'll pay more for it.

The other element of it that I think is pretty tough is there's a smaller market for people who want that's the right way to put this, For people who have experienced their own mistakes and kind of have a low enough you go to say, like, I want somebody to help me with this, compared to I think it was like decades ago the e trade adverts, where you know, it's like this very kind of like alpha male. I'm going to train and make lots of money and be such a kind of like just alpha male. Some words

I can't use. The idea there is, like it takes time and good feedback loops for you to realize these perfectly human faults within yourself and want to help handle them. I think at better in One of the nice things is that generally speaking, the people who we deal with either have already gone through that process and come out the other side. They've climbed Mount stupid and walked down the other side, or they just went around it entirely because they weren't interested in it, or it never really

appealed to them. One of the neat things we did years back was look at who was most likely to try to market time, both during raging markets and falling markets, and the answer was always young men, and that women, almost regardless of age, were really good at just kind of staying the course and not reacting to anything and

did much better for it. So I think the tempting thing is that you'll hear about the kind of the I don't know the sexiest, most glamorous, high growth things that are free and so on which work, but I think they tend to work as long as there's new, fresh, naive people who haven't gone through the process of Eh. I don't know, is this a good use of my time or should I really kind of like spend my time improving my own personal life or my own career rather than trying to trade stocks.

into the market. But what are some of the tools that Betterment's offering to just accommodate for our flaws to make it to where we are over the course of

the long run winning right? Like And that's I guess that's the difference here too, is that like in the short term, it may not be as winning of a proposition for the business right for Betterments, but it's almost like an altruistic approach to the customer and to business generally speaking, because it's like, look, over the long haul, you're going to vastly outperform what you would have done on your own.

that we made two or three years ago. And I think that is true for us as a business, and it's also true for individual investors. It's not month to month. It is I'm going to make a decision now, and hopefully it's going to pay off well in two to three years. So a few examples of how we try and make the boring, straightforward dollar cost average, low cost diversified investing interesting and fun and not the boring. Option.

Number one is goals. So you think about it as envelopes or buckets or just ways to separate out your money. The idea is that I have a goal that is I want to send my daughter to college. I've got roughly fourteen years left in that how much do I need to save every year when I put it into this portfolio that's going to glypath over time in order to make sure that she could go to college if she wanted to, or a new car, or a house

down payment, or the biggie retirement. So the ability to separate out individual pockets of money has a lot of benefits. Number one, the more that that goal has a meaningful emotive purpose for you, the better behavior're going to be around saving and investing in that goal. So my daughter's college fund, it has a picture of her. You can upload individual pictures to betterment, and it's got a picture of her actually at a graduation ceremony for my wife.

And so every time I see that goal, I'm reminded of, like, I want to invest for my daughter's future. I want to go to her graduation ceremony many years from now. This is what the purpose of this is, and I really want to make sure that I continue to save into it and know I'm not going to get distracted by what the market's doing over the next two months or three months, because this is a goal that I

am investing in for fourteen years. So gold based investing and making it evocative and meaningful for what the person's trying to achieve is one of the big wins.

individual is likely just to prioritize living for the now. Yeah, how important is it to kind of connect those tangible future realities to kind of our current living experience.

I'm here, what do I want to have happen? What's going to be required to get from a to BO on that path, the more realistic we can actually say, like, Okay, if I want to have a warm house this winter, then I need to go out and chop wood now so that I have it prepared for when the winter is cold. It is superpower. It's this power that we're kind of constantly a little bit living in the future. We care a lot about our future selves, and that works against the kind of the nawism, the short termism

of like how does it feel right now? What would relieve me when markets are going down. It feels anxiety. If you're paying attention to it, it pays. It feels anxiety provoking. You feel like you have to do something, you have to feel like active, you have to react to what's going on now. The more that you start thinking about I'm talking about Okay, I'm in this for twelve years for a purpose, which is my daughter's education.

It is not to make money. Sort of addressing your question directly, we people can like name their goals whatever they want for them. They can attach images to them, or you can keep it as the default. And I think the default name is something like build wealth, which is very generic and sounds good, but it's not very evocative. It's kind of weird. I want more, you know, I'm the Scrooge McDuck. I want more of what I got.

And so if your only benchmark for our things going well is do I have more than I put in, it's very it's very thrashy. Sometimes you're up, sometimes you're down. It's very emotionally volatile. On the other hand, if you're looking at okay, I am on track to send my kid to college, and I am saving and I'm investing in a way that it keeps me on track for it, and I still have a I don't know, seventy eight

percent chance of hitting that amount in ten years. All that anxiety and that thrash goes away, and you're kind of like comforted and relaxed because you're I know the future that I am building for is going to be correct. I'm not reacting to the present. I am building for the future. So much stuff, so much stuff around our interface, around the way we think about things is how can we help people focus on and build for the future.

How can we give them the tools to say, what's the range of outcomes I can expect over a year if I'm in this portfolio in the future, how much do I need to save if I want to hit this goal six years in the future. Instead of if you log into a brokerage or something, what hits you is the past you log in, it's just like, here's how you did over the past five days, here's how you did over the past three months. It's a fact, but you can't change it and there's no planning for it.

So the more that we can help people, we give them those tools to say, like, let's focus on the future and focus over the things we can control and change to make the future better. The better they invest in, the better we do as a company.

can't do it. So, coming back to some of the things we talked about before, I was looking at data around kind of thinking about like who do we need to talk to and how do we need to talk to them when markets are getting choppy around to specific news events. You can think about elections or the FED changing rates, or I don't know, some like you know, China trade deal, et cetera. Things that are likely to cause markets to be volatile that people never coming up.

And so we were looking at trying to predict who was going to be the type of person, not the individual, but the type of person who was going to de risk their allocation ahead of a scary event. And we were building up this model which was something on the order of like how old are you, what gender do you identify as, how long you've been with us, what type of gold do you have with us? And then two factors which were very powerful, more powerful than a

lot of the other stuff. Do you use our mobile app? And how often do you log it? And so you know, like I wasn't necessarily trying to figure out for a specific person, but I can go off of some demographics as well as a little bit of the observed behavior for you that I have and build out a model that it was I think it was like sixty or

seventy percent accurate. It's saying who was going to come in and do something that we were worried about, so that we could target just those specific people with communications and not hit the people who weren't so much of a risk with those communications. So I think it is a cutting edge area. I think the hardest part about it is either having the specific behavioral data of the person themselves or being able to predict it based upon other people like you.

in the sand. Okay, No, there are two different things. Oh, okay, gotcha.

forecasts are for the next quarter. And interleaven with these various sort of practical investing questions, we asked them some personality questions, one of which the Neuroticism scale, which is a very well established Big five personality scale that we thought might be linked to specific behavioral aspects and a base model that we were building off of. There was a research paper that was done by I believe George Lowenstein in some colleagues years back that said, how do

people when do they pay attention to their accounts? And it was a very easy model that was like, well, they want to pay attention when it's going to make them feel good, and they're going to not pay attention when they think it's going to make them feel bad. So they predicted whether or not people were going to log in to check their accounts based upon how well the market had been doing recently, and they found, you know, yes, it's true. People log in more when it's doing good

and log in less when it's doing bad. And they coined it the Ostrich effect. There's less attention paid when it feels like things are going to be bad. They did this with Vanguard client data and love Vanguard. Wonderful company, wonderful clients. They are a very specific type of client. You don't get day trader active management clients at Vantage. So we had access to online brokerage clients who were the counterpoint, people who for whom volatility and day trading

were the reason that they were there. And so we found a mix of things, you know, like some people were high neuroticisms, some people were low neuroticism. In almost all cases on our platform, when returns were bad, people also logged in more. So it wasn't like the ostrich. It was a mere cat. Whenever there are big moves, whenever there's danger, you're more likely to pay attention. So hence we called it the meerkat effect contra to them.

But also we found that the higher neuroticism was, the more sensitive to it you were, the more of a sort of anxious personality type that you had told us you had, the more likely you were to log in, especially when things aren't going well, and likely to react.

So it's a great example of like, yes, if we have good dimensions that we can kind of measure you on, like neuroticism, we could give you a pre screener to learn about you and say, okay, this person's at more risk of this kind of behavior, we should help them out more in this specific setting.

opposite would be true. And then you go on to write about the role of faith in investing and how important that is, and I was like, I don't know. I think I need Dan to explain that some more.

been disconnected. They don't experience pleasure and playing to the same degree that you or I would. They're still perfectly rational, they can do math, they can have conversations, et cetera. So you can almost think about these hyperrational Spock people, And in studying them and working with them, he noticed that they had a hard time making decisions because they couldn't kind of like be like, well, what do I want?

What's going to make me feel good? Because I don't have that internal representation of good or bad or pleasure or pain. So they would hem in hall on endlessly about like, well, you know, like this has these good qualities, and these have that's good qualities and just not make a decision. So part of the interesting thing is like that sense of I don't know, frustration when things take too long, or an instinctive reaction to something being good or icky is actually a core part of the decision

making because it forces you. It gives you a real motivation to make a decision rather than try and list all the pros and the cons out and one of the things that I've looked at a lot. You know, probably most people who are listening to this are familiar with investing. They have gotten over the hump of saying I am going to invest in some fashion. It might be through a four to one K, through the IRA, diversified individual stocks, whatever. Most people don't get to that point.

The set of people who invest, especially in some kind of a hands on fashion outside of their four oh one K is targeted funds pretty small. And that's because investing is scary and it's risky, and you come into it and that first decision you have to make where you're like, how am I going to invest? There are so many different competing ways of talking about it, Like I like value stocks, I like growth stocks. I have

this strategy that one et cetera. And we don't know which one of them is going to do well over the next any period of time. Right, you almost have to say, like, I am going to put my faith in this way of approaching things. Maybe it's the low cost diversifies the only thing that matters, and I'll be okay over the long run. I have faith that this will work out so that I can pull the trigger

and get invested. Because in the absence of some kind of short circuit that says like, just get in there, just do it, have some way, we would sit there and be like, well, I don't know, but the FED might do this, but China's importance to doing that, but this company's done really well. You would just end up going back and.

sticking with the decision. And I think that's where maybe a part of where that faith come comes into play too, because by receiving new data, like, yes, you need to absorb that information and take that into account, but it doesn't necessarily mean that you're going to immediately be reactive to the market because you've got a game plan, you've got an investment strategy, and there's.

been great for investors. But how do our expectations for our investment returns impact our decision making and how it is that we react or hopefully don't react to the market.

And one of the nice things about this is that you know if you set that out and say I expect a five percent growth over this many years, as time goes on, you'll know half of it. Right, You'll know like half of the way through your investment. Okay, actually I averaged out about nine percent returns. I'm ahead of where I thought I would be. This is great. I can take on a little bit less risk because

I'm ahead of the game, or de vice versa. But number one is don't focus on or try for requiring a high expected return because that puts you into a very fragile position, not just from a planning point of view, but also from a I don't know, like a take being being able to be taken advantage of point of view.

There's a great story by Barry Rittolets from when he was a young advisor where he was, you know, he had a prospective client who was chatting with him, and the client was like, so, what are your expected returns? And Barry was like, what like for the S and P five hundred and then guy was like, yeah, yeah, yeah, what are your expected returns? And Barry was like, I don't know, man, like nine percent, And the the client was like, well, this other guy I'm talking to you,

he says he thinks twelve percent. And Barry was like, what are we talking about here, Like, what like are we talking about who's more optimistic about the economy or is he saying that he's going to like beat my portfolio by three percent? But because the other advisor gave this sort of like strength, like just more optimistic figure about what's going to happen, the client went with them and they probably were disappointed when that didn't meet materialize.

So a good way to think about it, I think is just like keep your expectations low so that it's easy for them to be outperformed, and as that outperformance happens, you'll be closer to your goal, you'll be closer to retirement or whatever it is. It gives you more optionality later in life to pivot and change and use the extra money that you probably hopefully have gotten for other things and not be in the position of saying like,

oh no, those twelve percent returns didn't materialize. I'm in a bad place, all.

that folks are making. But there's a certain amount of life that you're giving up if you are thinking, okay, man, i've got to see you know, a saving rate of x amount in order to retire by age whatever, when maybe there might be an ability to take your foot off the gas a little bit, maybe do a little bit of coasting.

hope I'm good. And I think that's the difference is if you are saying I am counting on I am depending on a high rate of return to make the decision I am making today, make sense, you are putting yourself in a position where you can end up in a bad spot if it doesn't materialize, if this return doesn't turn out that way. And you know, for most of us that we're talking about is either like is

it ten percent or is it six percent? In the most extreme cases, there are people who, you know, the investment that they made was only going to make sense that they could guarantee you twelve percent return, and you know, they bought a house and we're trying to airbnb it and that didn't materialize, and then they took a humongous loss because they had to sell the house in foreclosure,

they couldn't afford it anymore, et cetera. One of the big parts of pain a lot of the times is when you have to deleverage, when you have to let go of something that was a highly leveraged investment in one way or the other because the returns didn't materialize, And that's very, very painful. So again, it's it's giving

yourself breathing room and free optionality. You can always live richer later if you kind of like had low expectations, but it's very hard to recover if you had high expectations that didn't materialize.

yourself up for failure. All right, Dan, We've got a few more questions we want to get to with you, including like do robo advisors eliminate the need for real life advisors? We'll get to that and more right after this.

It doesn't necessarily take away from existing ones. So I think most of the growth in robo advisors has been from people who were either not investing at all because it was too intimidating or they weren't sure how to do it, or DIY investors who are like, okay, you know, time to go to the chores. It's Friday. I'm going to go in and rebounce my portfolio. Got to get it done. I don't think many many people kind of

like left their advisor because of robo advisors. I think it just served a new space, but also betterment offers our platform for advisors, and that's one of our largest growth areas is advisors who you know, we're like the more updated, powerful Microsoft exell for managing their clients' finances.

They say, why would I ever want to spend time rebalancing or tax loss tarvesting or asset locating or putting together goals and saving plans myself when I could offload all that stuff onto a robo advisor And that means I get to more spend more time talking with my clients and you know, going for hikes with them, playing golf with them, whatever is meaningful, talking to them about like the really big prioritizations have to make in their lives.

So this is a very common model of kind of like what happens when some better technology comes onto the scene. What it does is it pushes the existing service providers up the value chain so that they can do more at a higher level with a more human overtone. And I think that's really what's happened here.

that impacts their own personal finances. And so do you think through behavioral finance and some of the insights and studies and apps that that y'all are able to implement, that it's possible to account for and not only account for, but even eliminate all of the just all of the mistakes that we tend to make as investors.

that advice either. Where I think there's some really nice possibilities is that more and more we're coming up with, I don't know what to call it, like protocols or systems where the incentives are better aligned to allow people to do that. So if you think about how open

source software works. Sorry, this is a very nerdy side case, but like they aren't necessarily paid, it's not necessarily business model, but there's a lot of kudos involved with it and pride in like writing a package and you can add to other packages over time in a way that it's like an open source project that people can contribute to. I have contributed to open source projects where I'm like, hey, here's a behavioral angle on this that I think could help and I want to add to it, and it

maintains itself because it's they're really interesting things. I actually think Crypto had some of this, where you know, here's the open blockchain. I'm not an expert in the stuff, but here's the open blockchain. Anybody can go in and analyze your trading records for your wallet and tell you when you've done well and when you've done poorly. The same thing is true if there's new like at protocols

that things like blue Sky run on. So I think it's been historically very hard to have really good aligned business models that serve a behavioral oversight function because people don't kind of understand how to pay for it. One of the few outstanding cases is dual lingo, which is very behaviorally informed in getting you to come back and keep your streak up and continue to learn the language. But there are very few of them where we pay

people to tell us like how to behave better. On the other hand, something where you can set up and work off of, like publicly available data, or something that doesn't require money changing hands quite so often. I think I have a lot of hope that there's more work that we can do there to help people.

What are maybe just kind of some normal, run of the mill things that people can basically funnel into their daily lives to improve how they're handling money, aside from the work that you do you're doing, and aside from the work that's being done in the payproal finance space.

What are my required outgoings? How much is leftover? I want to save this much of it and whatever is leftover after that, after I pay myself first, I can spend how I want. Do not sweat the coffees, Do not sweat the movie tickets. Do not look and micromanage the individual things of your budget, because all that matters is that you have been saving ahead of time, so you can spend how much you want on whatever you want.

And I think that that sort of setting up a budget and saving however much you can from it a starts to build up some really nice muscle around like Okay, I've got a budget, I've got inflows, outflows, I know what they're going to look like. It allows you to build further into Okay, what are the other things that I want to save for in the future, and how

do I trade them off? Against what I'm consuming now, So I actually I think a lot of it starts with some kind of process system, basically a budget that makes it easy for you to spend and save intentionally.

down to Atlanta. But do you have a big takeaway from our conversation with Dan Egan of betterment to know?

picture of where things are going to end up. And I think actually sometimes we undersell our abilities of where things could go, at least I think I did.

from the final outcome. And I think it's going to allow us to do the right thing, even though we might not have one hundred percent conviction. We have to exercise some of that faith he talked about, too sure.

can coast. And he's talking about having breathing room. He's talking about optionality, which is man, he's like speaking our language like and that's maybe that's why it was fun to talk with him, But like there is a difference though between like, Okay, what does it mean to say I know that I can coast. What does that mean? Well, it means that you don't have to take any risk. Okay, well what does that look like? It means having enough

in the bank to say, well, I don't have to invest. Actually, I can just count on what the bank's going to give me. Well a the rate that banks are paying. It's varying, as you know, and what we've seen lately is that is going down. But even still, I don't think anybody would make the recommendation that you should have all of your bank all of your money in the bank earning interest from what the banks are paying, as

opposed to actually putting it at risk. And so I guess what I'm saying is that, And I'm still processing and chewing on what he said. But it's not quite as binary as knowing that you can and hoping that you can. There's there's a spec there's a it's a dimmer switch in between, and you have to figure out where along that continuum that you, as an individual feel

comfortable taking on the risk associated with that. So it's good food food for thought for me, but hopefully for all the listeners out there that maybe think about where along that continuum they are as well.

growth to prove out in that account. So we're we're all doing the best we can with the information we have on with.