That humans are a species of incredible innovation in art, science, literature.
Yet of all the things we're brilliant at, investing isn't one of them. Why, Well, we're easily excited. We get focused on the wrong things, obsessed with what just happened rather than what might happen next. We're bad at understanding maths, and we despise delaying gratification. Top all of this off with unjustified over confidence, and you have a recipe for investing underperformance. As it turns out, when it comes to investing,
we're just not built for it. I'm Barry Redults and on today's edition of At the Money, we're going to discuss how to become more systematic and rules based in managing our money. To help us unpack all of this and what it means for your portfolio, let's bring in doctor Daniel Crosby. He's the Chief behavior Officer at Orion, where he develops tools, training, and technology to help financial
advisors apply behavioral science in their practice. He is also the author of the book The Laws of Wealth, Psychology and the Secret to Investing Success. So, Daniel, let's start with just a basic idea. Why is a rules based approach to managing money. So important.
Yeah, very good to be with you. Well, one reason is because rules work. You know, when we look at a meta analysis, so this is a study of all the studies on how rules fare. Simple rules fare against a PhD level discretionary decision making. Rules match or beat expert level decision making ninety four percent of the time, which is pretty staff. And we see this across context. We see this everywhere from medical diagnosis to stockpicking, to
financial planning to prison recidivism studies. That one's one of my favorite. They went from sort of having these soul searching interviews with prisoners to looking at two variables. You know, what are they in for and how did they act while they were in And they increase the efficacy of their judgments by almost four hundred percent. So they work is one reason. And they're cheap is another reason. You know, it's a lot cheaper to set up a checklist or a simple set of rules than to pay a bunch
of CFAs to try and get it right. So they work, and they work on a budget.
So I love the idea of the checklist because it plays very much into an issue that's a pet peeve. Of mine, which is investors tend to obsess about all these things they cannot control, things that are out of their diction, while ignoring the things that they can control. Talk a little bit about how creating a checklist allows you to focus on things that are within your control.
Yeah, very When I wrote the book, you know, the very first chapter, and I was intentional about the ordering. The very first chapter in the book is you control what matters most. Because I found what I think you find when you tell someone you work in markets, that you work in finance, they ask you about one hundred things. All one hundred are outside of their power. What's the FED going to do, what's the virus going to do, what's the war going to do, Who's going to win
the election? Stuff that is a almost inevitably unknowable and be outside of their power. So what I think we have to encourage people to do is to take the power back and to frame it that way, because things like fees, things like diversification, choosing to work with a professional, all of these things are within our control and are far more predictive of you crossing your financial finish line than any of that other stuff.
There's a great story in Michael Lewis's book about Sam Benkman Free and FTX about Jane Street Trading, and even though they got the twenty sixteen election results correct, they still were unable to anticipate what the market reaction would be. So not only are these things out of your control and they are unknowable, but even when you know it, Hey, what's the reaction of tens of millions of traders going to be? We really have no idea.
Yeah, no, it's true, like no one thought Trump would win, and then most folks who thought that he would win thought it would tank the market. Both things were proven wrong.
H really amazing. So let's bring this back to the investing decision making process. You emphasize why the process of making good decisions is so much more important than trying to predict market movements.
Explain, Yeah, it's really about being the house and not the degenerate gambler.
Right.
If you look at all the bright lights in Vegas, all that gets paid for by tilting probability in favor of the house. And if you look at a lot of casino games, the edge the house has is not dramatic. I mean, in some cases it's infinitesimly small, but tilting probability in your favor time and time and time again. Showing up doing the things that are within your power time and time again, pays for some nice lights and
some nice fountains, as we see in Vegas. So that's all we're trying to do here, control the controllable tilt probability in our favor in a small way. You're not always going to get it right, but you're always going to be at the wheel.
So I mentioned in the introduction that we're all filled with so much over confidence. You have a chapter titled You Are Not Special. Tell us about why investors need to stay humble and why we're all subject to the same biases and errors as everybody else.
Well, I love this one because I think it demonstrates how psychological biases can serve us. They serve us well in some domains in life. If we look at over confidence bias, it serves us really nicely. In some ways. People who exhibit it are happier, they're more successful, they're more likely to be successful entrepreneurs. God, they're definitely more likely to run for office. Right, There's all of these things that over confidence does, but when you apply it
to markets. There's three specific ways that we're over confident. The first is we think we're better than average right, smarter, better, faster, stronger, better at picking stocks, And that's the one that gets the most publicity. But there's actually two others as well.
One is we think we're luckier than average. Ask people, you know, what's the likelihood of something happening to you, like getting divorced, and like, effectively, no one says they'll get divorced, even though you know one and two people gets divorced. No one thinks they're going to get cancer or you know, have diabetes, or you know, on and on and on. But if you ask people about their odds of finding love or winning the lottery, they dramatically
overrate these probabilities. So we sort of tend to own the optimistic and delegate the dangerous. That's a second sort of facet of overconfidence. And then the third one is we think that we're more prescient about the future than we actually are, Like we think we're better at forecasting what's going to happen. So these three forms of overconfidence
are a pretty toxic cocktail of bad decision making. So we really you know, our mutual friend Jim O'Shaughnessy has this great line in his seminal work What Works on Wall Street that I'll butcher here, but it's effectively like, look, rule one. Step one is understanding that you are prone to all of the same screw ups as the next person, and until you sort of deeply internalized that you shouldn't start.
Yeah, Jason's why. I guess Danny Khneman what he does to avoid all of the behavioral biases and heuristics that him and Amos Tversky discovered. And his answer was nothing. We can't avoid it. They're just totally unavoidable. Hey, if Danny Connoman can't avoid them, you know what hope did the rest of us have?
Yeah?
So there's another line I really appreciate, And this perhaps is because I began on a trading desk, and what led me to realize it was time to move on was how much fun I was having, regardless of my p and L. You right, if it's fun, you're probably not making money. I bet a lot of traders can confirm this. Tell us why fun and making money are not necessarily consistent, and what we need to do to be more methodical and more disciplines.
Yeah, it's really like one of these harsh truths about I refer to it in the book as Wall Street Bizarro world. How the truths of every day are sort of one eighty to the truths of markets. And one of the things that we find is some of the most exciting, most fun ways to try and make money in the markets are the most deleterious to our wealth.
You know, you look at day trading. The most comprehensive study on day trading ever done was out of Taiwan, and they found that one in three hundred and sixty day traders show evidence of skill. So is day trading fun?
Like?
Absolutely, it's a blast, right, Like making short term trades can be fun, it can be intoxicating, it can be exciting, but you know, the chances of you being good at it are vanishingly small. You look at other stuff like IPO investing. You know, everyone's got this story about if you would you know, if you'd put ten thousand dollars in video or Apple or whatever, you'd be a gazillionaire now. But we know that on average, the average IPO does twenty one percent worse than the s and P five
hundred in the first three years. And so again, is IPO investing fun? Yeah? Absolutely, but you are the gambler. You are the gambler and not the house, and you're unlikely to secure that monet if you're engaging in these sorts of fun behaviors.
Let's talk about forecasting is for weathermen. Why are we so bad at forecasting? And what should we focus on?
Well, it goes back to that. You know, it's one of those primary forms of overconfidence. And the research on
this is just wild. You know, Philip Tetlock did sort of the seminal research on political and financial forecasting and found that, you know, even the experts are terrible at this, and in fact, the more famous and expert, the worst they tended to be because you get famous as a market prognosticator is making sort of a once in a lifetime black swan prediction, and then you tend to continue to bang that drum because it worked the first time, and you know, history on average is pretty average, and
then you're wrong. But the reason we're always going to look for this is the way that we're wired. Right. Our brains are are two to three percent of our body weight. But they're twenty to twenty five percent of
our caloric expenditures in a given day. And so when we look at people again hooked up to an fMRI machine who are watching cable financial news, watching someone make predictions about what's going to happen, the part of their brain associated with critical thinking and decision making actually goes to sleep, which is candidly what we are looking for, right We're looking for that peace of mind. We're looking
to think less and go into energy saver mode. So as bad as we are at forecasting, there will always be a market for some sort of certainty. And I think the only thing that we can do is to work with a financial advisor who can give us some sort of certainty around our plan, our purpose, our immediate financial lives, instead of delegating that to some impersonal talking head.
So I'm glad you brought up the financial advisor. You discuss how hard it is to do this alone and why you should seek professional advice and support, if for no other reason then to help you manage your biases and your emotions. Discuss your experience with people working with professionals.
Yeah, this is one of probably the two most powerful things you can do to manage those behavioral biases that Danny Kneman talked about, right, I mean, he talks, as you said, about the futility of it. I think the two best hopes we have against behavioral bias is automation and working with a professional. The data is very clear now that people who work with the professional tend to do better than those that don't. And when we look at a twenty sixteen Merrill Lynch study, the things that
an advisor does for you are all additive. Like they sort of broke this down by the different things that an advisor does in his or her day, everything from you know, security selection to asset allocation to tax alpha.
It all helps.
But the thing that helps the most is again this behavioral coaching, the emotion management, the guidance around decision making, keeping you from investing in your son in law's dumb business. You know, just these these pivotal points along the way. That's really where it adds about us four times as much value as the other stuff. And what's cool for me, as the son of a financial advisor who works with financial advisors every day, is people who work with an
advisor have better marital communications. They have higher levels of aggregate happiness. They're more prepared for an emergent. See like they have all these non financial things in their life that get lifted because money touches everything we do. So if you can get that right, a lot of other boats in your life to start to rise as well.
So to wrap up, humans are great at a lot of things, but we also come prepackaged with a lot of evolutionary baggage. We're easily excitable, we make poor decisions, we think we're special, we're wildly overoptimistic, and we tend to overreact to every sign of trouble like it's the end of the world. We're much better off if we have a rules based, systematic approach to managing risk and
investing for the future. Rather than making these decisions on the fly to help your portfolio, you really need to think about what is the best result for you over the long haul, not just make making these decisions spur the moment. I'm Barry Rudolts. You're listening to Bloomberg's at the Money
Little little that you burnt, that you burn