The Importance of Behavioural Finance with Daniel Crosby

So we’re on episode nine now of series two and one of the common threads that’s come up in every single episode is around this topic of behavioural finance, and how our behaviours influence how we achieve our financial goals and shape our financial intentions around money. I’ve been really fascinated by exploring this topic myself for the last sort of two years. I spoke at a conference last year that was run by a fellow financial planner called Andy Hart, and his conference was called Humans Under Management. Andy’s a massive believer in the idea that our jobs as financial planners and financial coaches is to help you to achieve financial success by helping you to manage your behaviours around money.

If you’re not already listening to Andy’s podcast Maven Money, it’s another great one to add to your subscribe list. A lot of what Andy talks about is about nudging people in the right direction to make sure that you stay on track with your financial behaviours and your financial habits.

So today we are welcoming Dr. Daniel Crosby, who is a psychologist and a behavioural finance expert who helps organisations to really understand the mind and the financial markets. In Daniel’s second book he talks about his 10 Laws of Wealth and this then feeds into him talking about the investment management side of things.

His first book was called Personal Benchmark: Integrating Behavioral Finance and Investment Management, and he’s also just published his latest work, The Behavioral Investor, which is a look at the kind of neurology, psychology and physiology around how we make financial decisions. Daniel’s married with three children, and we explore some of his own relationships with money growing up as a child. His father was actually a financial adviser, so he grew up in a household where they did talk about money and his dad encouraged him to invest in the stock market. One of my favourite things is hearing him talk about how he teaches his three kids about how to invest. His nine year old daughter loves Disney, so she invests in Disney shares! So we talk about children and how we can teach kids about money, and then we dive into some of the human behaviours, and why sometimes we’re silly with money, and what emotions influence our financial decisions.

Listen to the interview

Hi Daniel, can you tell us a little about yourself?

So I am the chief behavioural officer at Brinker Capital, which is an asset manager based outside of Philadelphia. So that’s probably not a title that a lot of people have heard of. But basically my job is to design training tools and technology for investors; I help them make better decisions with their money. So my job is sort of the intersection of psychology and financial decision making. So really just everything I do, whether it’s writing books or designing technology is around it helping investors make better choices with their money.

How did you go from studying psychology into the finance space?

I grew up the son of a financial advisor, so my dad is a financial advisor. And so I grew up in a very non traditional  household where we’re discussing stocks at the dinner table and my dad was helping me invest from a very young age. But in college I fell in love with psychology too, and so, long story short, I was looking for a way to combine these two worlds and set out initially to be a therapist.

But I found after about three years of doing therapy full time that basically I couldn’t cut it. It was too heavy for me. I was worried about my clients all the time, and I was bringing their problems home with me. I couldn’t sleep, and I found it really difficult to enjoy my own life knowing there was so much sadness in the world. I felt like I needed to look for a nonclinical application of psychology and decided to combine my two passions.

That’s so interesting, and you’re right that money is still such a taboo subject. So how did your dad talk to you about money?

Well, it’s interesting because, you know, he taught me these lessons, but I think as is often the case with the lessons you learn from your parents, you don’t realise how deeply they’ve taken root until you get into adulthood and you find yourself in situations where you need to apply them. One thing is that my dad paid off our house when he was 35, which is incredibly young. And the way that he did that is by us never taking family vacations and basically eating beans every night. He was so singularly focused on getting out of debt that it just wasn’t much fun in the Crosby household for those early years when he was paying off the house. But I saw  how singular his focus was, how all consuming it was.

I grew up in a conservative religious household. My Dad’s a very devout person and I’ve never heard him swear. And he always said that debt was another four letter word, and we were not allowed to say the word debt in our home because he hated it that much. So that was very formative and influenced me are going forward. But he was also a big investor. He was very interested in the stock market, and I think I learned good lessons early on about taking appropriate risks and risk management, and how owning stocks was just really owning part of a business. So talking about the stock market in an exciting way, that you could have a share of a company that maybe you love and how we can give back to the world through investing.

The word stock market I think is really super scary for a lot of people whereas actually if you think about it in that language of owning a stock in a company, that’s exciting, isn’t it? I think it’s become too much of a video game. We just kind of watch the red and the green and the up and down and people have become divorced from what it truly is, which is partial ownership of a business. And so when you think I can own part of a business and I can vote my shares in a way that impacts the way this business going forward, and I can make the world a better place,  through socially responsible investing, that’s really powerful. This might be a bit of a cynical opinion and perhaps not a very popular one, but your money votes a lot more strongly than your actual vote does. I mean, the way that you vote with your money counts for a lot more than how you vote at the ballot, even though both are important. So if you want to bring about this kind of just world that you dream of, there’s hardly a better way than being thoughtful about how you spend your money.

I love that. So how do you use this to influence how you teach your children?

I have three. I have a nine year old daughter, a five year old son, and a two year old daughter. So I struggle a bit because I don’t know what kind of world my kids will be working in in terms of how technology is evolving. I don’t quite know what to prepare my kids for, but I do know that whatever the world looks like when they’re adults, I know that there will be a heavy dose of creativity and entrepreneurial spirit. So in particular my eldest daughter, who’s the one who’s can get some of this stuff right now, I’m teaching her to be entrepreneurial. I’m teaching her to be self starting and creative because those are skills that aren’t going anywhere. And I also think they’re going to be increasingly in demand. I absolutely talk to all of the kids about this, and my eldest is a proud Disney shareholder. Disney has been on fire lately, but you know, you have to talk to them too about the risks; liking a company doesn’t necessarily make it a good investment. And so we’ve used their interest in those companies as a teaching vehicle to learn more about how to analyse a stock.

So thinking back to our early experiences with money in childhood, what are our natural behaviours with money as humans?

God could not have designed a worse investor than we are. I basically, Every impulse we have, and I write about this in my new book, The Behavioral Investor; everything from the way that our brains are wired to the way that our society functions, and the way that our bodies work,  everything in our environment conspires to make us bad investors. That can sound a little disheartening, but once you understand some of these things, I think you’re well prepared to guard against some of these errors.

And is there any gender difference there between how women behave around money compared to how men behave with money?

Yes. Women are much better with money than men are. Women are less ego driven, which is probably no surprise to anyone listening to this. So women are less over confident than men, and are less likely to make broad sweeping changes. Women tend to be more conservative and stay the course. Women are less hormonally challenged than men, and I know that’s the opposite of how it’s portrayed in popular culture. Men have 10 times the testosterone of women and there’s been interesting studies done on how testosterone and winning actually makes you stupid. Basically, if you’re on a winning streak, if your stocks are doing well, your testosterone increases and it increases to such a point that you begin to become too aggressive or over confident and then can make a mistake which sends you spiralling back the other way. And so in every way, every study suggest that women are better investors than men.

So is there like a, a prime time of when you should make financial decisions during your day?

One of the biggest findings of behavioural finances that you want to minimise the decisions you have to make. To every extent possible, you want to automate them. Personally, every two weeks money comes out of my checking account and goes into my retirement account, whether or not my stomach’s full, it’s just automated. Don’t leave it to the whims of chance or the whims of your hunger, satiety or hormones or hormonal levels that day. Just automating it is one of the most powerful things you can do. Beyond that, the big rule is just to avoid extremes. There’s an acronym I learned when I was doing work with 12 step recovery programs; HALT. It stands for Hungry, Angry, Lonely or Tired. And the thought is you should never make a decision when you are any of those things. They’re not good times to be making life changing decisions. And the same can be said of money. If you’re feeling at an emotional extreme, whether it be greed, fear, or, or anything in between, it’s probably a good time to sit that one out.

So how do emotions influence how we make financial decisions?

To put it simply, people who are happy tend to under rate risk. People who are in a good mood tend to see sunshine on the horizon, whereas people who are in a bad mood tend to see risks everywhere. So we always see the world through the lens of whatever emotion we’re experiencing. And so sometimes that’s why you just need to avoid these emotional extremes. Emotions are never going to go away, but whatever emotional state you’re in, you’re going to see the world of investing in money through the lens of that emotion.

Interestingly, I cite research in the book that shows that some of the best investors in the world are people who have had traumatic brain injuries and have damaged the emotional processing centres of their brain. So they’re not able to experience strong emotion or any emotion. They’re great gamblers and they’re great investors, but they have trouble picking out what kind of ice cream they want and what kind of suit to wear because emotions impact every decision that we make, whether we know it or not, even silly decisions about what flavor of ice cream to have. But we can do our best to stay out of making big decisions when we’re emotionally volatile.

One of the things we talk about quite a lot is the idea of emotional anchoring and fear around money and particularly the jargon involved. Do you see that in the work that you do and the work that you’ve written about as a behavioural finance expert?

Yeah. You’re spot on. I think jargon is one of the ways that professionals justify their fees. If we know all these big fancy words, we can bring you into our office and wow you with our acumen and then charge you. But I think the best financial professionals in the world are demystifying the world of investing. Trying to cut through that jargon and make this as simple as possible because financial planning and investing are quite simple. The nuts and bolts of what you ought to be doing is really quite simple. Save a little bit every week, spread it around, leave it alone.

I think we absolutely as an industry need to cut through this jargon and empower people to know that it’s not as hard as they think, but it is behaviourally hard. It’s psychologically hard to do the right thing, just the same way that maintaining a proper weight is really all about diet and exercise. I mean, that’s all; but it’s far easier said than done. So the same applies in the financial world, right?

And that’s why I think I feel so passionate about this, because I’ve been through my own journey, and I understand what it’s like to feel like you’re in this constant cycle of not able to save or invest because I’m just spending all my money. Do you see that in the work that you’ve done? Maybe that childhood traumas or aspects of bullying and eating disorders and those sorts of things can have an impact on how we behave with money?

You mentioned earlier how much more likely we are to talk about other taboos like sex or religion than we are about money. I’ve been doing some work in the last year around couples and money and helping couples become more explicit in outlining their values and their preferences around money. But what I found is that in the US 12% of married couples have never had a conversation about money. 40% never talked about money before they get married. It’s incredible to think that; I don’t even know how you could get through a month or a week without talking to your spouse about money. So that shocked me. So yes, money is absolutely still seen as a taboo subject that we just don’t talk about enough.

So these underlying traumas can kind of operate in the background. Like the way you talk about your personal spending; I’m spending money to try and be happy, to feel skinny, to feel better about my body. But that’s operating in the background and it’s only with the benefit of of hindsight that you’re able to look at that and say this is what was going on. So we need to become way more concrete about the ways that we talk about our money values. We needed to become way more comfortable about it. I think with respect to your audience in particular, women are socialised to not care about money. Women are discouraged from talking about money in comparison to men. So I think that the added benefit to the folks that are reading this is double that of what it is to a man, just because of the way that women are sort of discouraged from talking about or thinking about money, or thinking about being powerful.

How does somebody even begin to uncover and unravel maybe how they’re feeling about money?

I think we need educators like you because money has become this proxy for liquid happiness, right? We can’t measure things like well-being or happiness very concretely, so money is an easy shorthand for that. We assume that if we’re rich or if we’re spending a lot or if we have a well packed closet that we’ll be happy. And yet all of the research shows that money cannot buy you happiness after you have your basics covered.

Money absolutely does buy you happiness relative to those who don’t have enough money for those basic things such as food and shelter. But once you get your basis covered it doesn’t help. And we need to be telling that story. We need educators like you and me out there. I’m talking to the world about what money does and doesn’t do because it doesn’t buy happiness. It buys the absence of sadness or the absence of worry, but it doesn’t buy meaning or fulfilment or happiness. And I think when people can rid themselves of this notion, I think they make better choices with their money.

I love the way you described that like buying by the absence of sadness.

Body confidence one is a great example. Actually, an interest in eating disorders is what got me into the business in the first place, so this is a passion of mine. You might think on the surface my problem is around money, but you dig a little deeper and you go, you know what, this is really about me spending money because I lack body confidence. And then you do a little deeper and you see I lacked body confidence because of XYZ. I think we need to always be digging and always be trying to understand ourselves at a deeper level because it’s an easy socially acceptable thing to be silly with money, but it might be masking bigger psychological problems. And we need to have the courage to keep digging.

We are quite open now, particularly nowadays, talking about mental health, but we’re still not particularly open about talking about money and problems that we’ve had with money. But I think the two are so connected, right. If we have mental health or psychological issues it’s going to impact the way that we feel about life and the way that we respond and behave. So I just think it’s incredibly important to talk about all of these things.

Yeah, I absolutely agree. And I’ve been pleasantly surprised at, at the ways in which mental illness has been de-stigmatised. But with respect to money, if you don’t have much money, you know, that’s looked down on in society, and I think the message is work harder, do better. But then if you have lots of money, I think the societal message is Yuck, and then if you’re average, nobody wants to be average.

I found out early on when I was giving IQ tests that nobody wants to be average. You can tell someone  they have a learning deficit and they go okay, we’ll figure out how to work around this. And you tell someone they’re very smart and they go okay, great. But you tell someone they’re average and they’re very upset. So there’s really no good place to be with money. I think the poor are looked down upon, the rich are looked down upon,and no one wants to be average. So I think it’s a really hard spot we find ourselves in with respect to money.

I see this all the time with women in business; they feel like I have to put more hours into their business, more money. And it’s this subconscious message that we hear about working harder rather than smarter. People think the word wealth is not a great word because wealth has become synonymous with greed.

I think we’ve confused wealth and hard work in a very profound way because there are plenty of people working very, very hard and just barely getting by. But that’s not the way that society views it. They view it as sort of a badge of honour. So I think we need to decouple some of these things. And you see a lot of this hustle harder mentality in entrepreneurial circles. If you’re not waking up at four o’clock and drinking your green smoothie and doing a two hour workout before you go to the office, then you’re not doing it right. There’s a lot of bad messages out there and that can leave us open to burnout and other sorts of negative psychological fallout.

Yeah, I see that a lot in my space. The online space can put a lot of pressure on women. They think ‘if I’m not earning £10,000 every month in my business then I’m not successful.’

The first book I ever wrote was called Personal Benchmark. And it’s a pretty hard read candidly, but the overarching point was run your own race. Figure out your measure of success and run relative to that because there are a lot of really impersonal, damaging messages out there. We have to become informed consumers of content. One of the things when I was working in an eating disorder treatment centre that we taught the women to do was become critical consumers of beauty messages.

When you see the cover of magazines, if you gain an understanding of what went into this, the airbrushing, the contouring then you can critique it and critically examine the messages that are being sent to you. And I think the same rules apply in financial wellness. You need to understand that the messages that you’re getting are not there to make you happy or even wealthy and they’re someone else selling something. You need to understand that and, and take them for what they’re worth.

That’s really interesting. I wonder whether there’s any research around a woman’s cycle, whether there are particular times of the month where we may be more confident and better to make decisions around money than other times of the month based on hormone levels.

There’s none that I’m aware of, but I don’t think it’s a silly question because one of the things that I write about in my book is that simple things like hunger greatly impact the way that you make decisions around money. I cover some research in my book that talks about how the ancient hunter gatherers were conservative at different times of the year and more aggressive during different seasons of the year, and how that factors into the way that we make decisions now. We are profoundly influenced by bodily cues, everything from hormonal cues to hunger cues, sleep, and caffeine are all examples. So it makes absolute sense to me that, that a woman’s cycle would have some sort of impact.

One of the things I love about your laws of wealth book is when you talk about the idea that you control what matters most.

I was very intentional when I laid out the rules and the laws of wealth and I I sequenced them in a meaningful way and I wanted investors to understand that you control what matters most and that that’s a layered conversation, because part of what that means is your behaviour is the best predictor of whether or not you reach your financial goals. You know what the stock market does then you engage in a handful of smart behaviours, like staying the course, saving regularly, investing in yourself so that you can progress and get raises. Those things are what matters most. But it also refers to the very thing that you’re talking about today, which is being intentional about the messages that you take in and the kind of people you surround yourself with.

Whether it’s health and wellness or wealth messages, the kind of things you’re feeding your brain have a great deal to do with how content you feel. Everything from the kind of neighbourhood that you choose to live in to who you follow on Instagram is going to have a great deal to do with how happy you are. And I don’t think we always take ownership of that. I think we can be too passive and let the world happen to us sometimes rather than trying to curate the messages we’re putting in our heads.

So rule number two in your book is that you cannot do this alone. Why is this so important?

So you cannot do this alone was my sort of nod to the need to work with a financial professional, but not for the reason that you think. All of the research shows that when most people engage a financial professional, they go, well, I’m going to hire her because she’s going to help me get eye-popping returns, and that’s going to be what decides my financial success. The research shows two things; people who work with financial professionals do much better than those who don’t, and the second thing the research shows is that it’s not because these financial professionals are picking great stocks.

It’s because they’re keeping you from being your own worst enemy at a handful of times when you want to sabotage your well-being, or when you want to sell out or go to cash or do some other dumb thing. So that’s the twist; you need to work with a professional but not for the reason that you thought.

I talk about this a lot in my speaker events, because if we focus on relationships with clients and their behaviours, that’s where we can add value. Keeping you on track is the best thing we can do, because none of us truly know what stocks are going to outperform other stocks. We can have an educated guesstimate, of course. But yes, the only certainty we can provide is by keeping you on your path. But we’ve got a little way to go, I think, in this country in terms of getting all financial professionals to think in that way.

No one can perfectly choose what the next hot stock is going to be. But let’s just suppose for a minute that you could, let’s just suppose for a minute that this is a skill you had and that you’re going to put your clients in the best performing mutual fund and see incredible performance for them. Let’s just pretend that you could have known that from the outset and you put your clients in this fund, but the average client return in that mutual fund was negative 11%, because what happens is everybody hears about it and they jump in. It has a period of bad performance, just like everything does, and everyone jumps out thinking it wasn’t so hot after all. Then it goes back up again. Everyone jumps in and the cycle repeats. And so even if you could know the end from the beginning, your ability to capitalise on that is still impacted by your ability to behave correctly. So the work of a financial professional to keep their clients in their seat is absolutely the most powerful thing you can do.

It’s that kind of herd mentality, isn’t it? I do think that as women we’re less likely to make rash changes to our portfolios once we are invested, but it’s getting invested in the first place that’s the difficulty.

Yeah, it’s interesting. I’ve said lots of nice things about women as investors, but the things that women need to be careful about is things like the gender pay gap. There are things like dealing with inequality that we as a society need to root out. Then there’s also the issue of women not asking for raises and not applying for that next big job. Studies have shown that men will go out for a promotion when they meet 50% of the qualifications. But women will wait till they tick every box. Women need to be going for these big jobs, asking to get paid what they deserve to be paid. And then the other thing that women need to consider is that they live longer, and that requires you to take more investment risk to plan for a longer future.

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