Ep # 80 - Navigating the Behavior Gap: Why the Average Investor Underperforms the Market with Dr. Daniel Crosby
Dr. Daniel Crosby joins Joe to discuss the impact of behavioral biases on retirement planning. They delve into overconfidence as a key bias, emphasizing its role in risk-taking behavior and decision-making. Dr. Crosby advises automating financial processes and seeking professional guidance to bridge the behavior gap.
The conversation also previews Dr. Crosby's upcoming book, "Soul of Wealth," which explores 50 essays on mind, money, and meaning, offering valuable insights for those navigating the psychological challenges of retirement.
What You’ll Learn in Today’s Episode
Overconfidence in Decision-Making: Dr. Crosby highlights overconfidence as a significant behavioral bias affecting investment decisions. This bias manifests in individuals overestimating their skills, luck, and knowledge about the future, leading to potentially risky financial choices.
Behavior Gap Awareness: The concept of the behavior gap, representing the disparity between market performance and individual returns, is discussed. Dr. Crosby emphasizes the importance of minimizing this gap by automating financial processes and seeking professional advice, as advisors help prevent catastrophic missteps.
Longevity Risk Consideration: A key consideration for retirees is the potential underestimation of longevity. Dr. Crosby suggests that individuals may live longer than actuarial charts predict, requiring a reassessment of risk tolerance and a potential need to take more calculated risks later in life.
Holistic Retirement Planning: Dr. Crosby introduces the idea of holistic retirement planning, going beyond financial aspects. He encourages listeners to prepare for a longer and more vibrant life by considering personal fulfillment, purpose, and contribution in their post-working years.
Upcoming Book - "Soul of Wealth": Dr. Crosby provides a glimpse into his upcoming book, "Soul of Wealth," comprising 50 essays on mind, money, and meaning. The book aims to offer readers insights into a richer, more purposeful life, touching on topics beyond traditional financial advice.
Ideas Worth Sharing
"When we look at the research, though, the number one predictor of whether or not you hit those retirement goals is really down to interpersonal factors, personal factors, your savings rate, whether or not you're maximizing that human capital.."
"The behavior gap is just the delta or the chasm between what the market gives us and what we take home."
"Automate your process, get someone in your corner, and then a lot of the higher level stuff takes care of itself."
"Retirement is a relatively new phenomenon... make sure you have something to work on that helps you scratch that itch to be better every day."
Resources in Today’s Episode
Retirement Planning Simplified
Ep # 23 – YRPS – Behavioral Finance and Scientific Based Investing with Christian Newton
“The Creative Act: A Way of Being” by Rick Rubin - The Creative Act is a beautiful and generous course of study that illuminates the path of the artist as a road we all can follow. It distills the wisdom gleaned from a lifetime’s work into a luminous reading experience that puts the power to create moments—and lifetimes—of exhilaration and transcendence within closer reach for all of us.
Overconfidence and Emotions: How Behavioral Biases Impact Retirement Investing
Have you ever heard these myths about retirement planning and investment decisions?
Myth 1: "I can predict the market's movements based on external factors."
Myth 2: "I'm better at stock picking than the average person."
Myth 3: "I don't need to take much risk in my retirement portfolio."
If you're interested in behavioral finance and this psychology of money thing, it’s an opportunity for you to learn more about yourself.
In this episode, you will be able to:
· Discover the hidden influences that affect your investment decisions and how to overcome them.
· Uncover the impact of overconfidence on financial choices and how it could be shaping your investment strategy.
· Learn about the behavior gap in market performance and how to navigate it for better financial outcomes.
· Assess your risk tolerance in investment strategies and find out how it shapes your financial future.
· Explore the emotional aspects of investing decisions and how to use them to your advantage in retirement planning.
Longevity Risk and Retirement Planning
In retirement planning, we tend to speculate on the length of retirement, which more often than not, gravitates towards underestimation. This miscalculation is what Dr. Crosby calls "longevity risk." Planning for retirement is not just financial; it's about envisioning your future life beyond employment, considering how you’ll engage your mind, find purpose, and stay happy. Dr. Crosby warns against the common mistake of underestimating your lifespan. The future is longer than you think, and living a fulfilling retirement requires a balanced focus on your finances and personal aspirations. It's about planning for a sustainable and meaningful life in retirement.
Risk Tolerance and Retirement Planning
When it comes to retirement planning, understanding your risk tolerance is like putting a compass in your pocket. It gives you a sense of direction, lets you navigate turbulent financial waters, and guides your investment decisions. Risk tolerance isn't just about gut feelings towards market fluctuations; it's about your financial ability to weather storms, your emotional capacity to remain unaffected by them, and your long-term risk preferences. Truly understanding your risk tolerance, therefore, means unpacking the interplay of these elements. It's also about recognizing that personal factors such as savings rate and risk management play a pivotal role in achieving retirement goals. Dr. Crosby introduces "risk composure" as the short-term emotional component of risk tolerance, a critical factor that often gets overlooked in financial discussions. He underscored the importance of assessing not just our long-term risk preferences and wealth-based risk tolerance but also our reactions to financial ups and downs. How have we responded to past market discords? Were we piqued or nonchalant? Mapping out these emotional reactions can offer valuable insights into our financial psyche, contributing to more effective personal financial planning.
The Value of Working with a Professional Advisor
Engaging a financial advisor can be a game-changer in your financial journey. The broad perspective they gain from handling a spectrum of clients equips them with experiences and insights that can guide you through the labyrinth of financial decisions. They not only help you bypass costly errors but also provide the kind of behavioral guidance that can significantly improve your returns. Dr. Crosby advocates for the undeniable value of professional advice. He emphasizes that those working with financial advisors often fare better, owing largely to the behavioral guidance they receive. From navigating complex financial decisions to aiding you during turbulent market times, an advisor plays a pivotal role in ensuring your portfolio is attuned to your long-term financial aspirations.
The resources mentioned in this episode are:
· Pre-order The Soul of Wealth on Amazon to get Dr. Daniel Crosby's latest book on mind, money, and meaning.
· Listen to Dr. Daniel Crosby's podcast Standard Deviations for more insights on behavioral finance and psychology of money.
· Connect with Dr. Daniel Crosby, PhD on LinkedIn for ongoing updates and discussions on financial psychology.
· Participate in the book giveaway to win a copy of Dr. Daniel Crosby's book and learn more about behavioral finance and retirement planning.
· Stay tuned for details on the book giveaway and how you can get a copy of Dr. Daniel Crosby's insightful books.
Timestamped summary of this episode:
00:00:01 - Introduction and Behavioral Biases
Dr. Daniel Crosby discusses how behavioral biases impact investment decisions, emphasizing personal factors over external macro factors in achieving retirement goals.
00:02:36 - Ego and Overconfidence
Dr. Crosby explains the overconfidence bias, highlighting people's tendency to overestimate their abilities, luck, and knowledge about the future, leading to poor financial decisions.
00:05:08 - The Behavior Gap
Dr. Crosby shares a study on the behavior gap, illustrating how investor behavior affects their investment returns, emphasizing the need to minimize the gap and capture the market's potential.
00:07:21 - Risk Tolerance and Retirement Planning
Dr. Crosby delves into risk tolerance, capacity, and composure, emphasizing the importance of considering all three factors in retirement planning and portfolio construction.
00:13:07 - Emotions of Investing in Retirement
Dr. Crosby discusses the emotional challenges in retirement, including the loss of meaning and purpose, fear, and greed, and provides insights on navigating these challenges in retirement investments.
00:17:31 - Automating the Saving and Investing Process
Dr. Daniel Crosby discusses the importance of automating the saving and investing process. By harnessing human behavioral tendencies like laziness and forgetfulness, people can work with their behavior rather than against it to secure their financial future.
00:19:26 - The Value of Working with a Professional Advisor
Dr. Crosby emphasizes the importance of working with a professional advisor. Advisors provide valuable insights from simultaneously living 100 financial lives, helping clients avoid catastrophic missteps and minimizing the behavior gap.
00:20:58 - The Soul of Wealth - New Book Announcement
Dr. Crosby introduces his new book, "Soul of Wealth," which delves into 50 essays about mind, money, and meaning. The book explores the intersection of money and the good life, offering reflections on wealth and life more broadly.
00:24:22 - Retirement Portfolio Construction
When constructing a retirement portfolio, Dr. Crosby advises considering longevity risk and the need to take more risk later in life. He urges retirees to prepare for longer, vibrant lives and to address the personal aspects of retirement to avoid a mental health crisis.
00:27:25 - The Holistic Benefits of Behavioral Finance
Dr. Crosby encourages listeners to explore behavioral finance as an opportunity for self-discovery and improvement. Engaging with the discipline can lead to holistic personal growth, making individuals better parents, grandparents, spouses, and money managers.