117: Coronavirus and Your Retirement with Daniel Crosby

[INTRODUCTION]

Casey Weade: Today's guest is Dr. Daniel Crosby, psychologist, behavioral finance expert, and asset manager here to help you understand the intersection of your mind and the markets. He is a New York Times and a USA Today best-selling author of multiple books. And most recently, The Behavioral Investor named the best investment book of 2017 as well as one of my personal favorite reads of the past year. This conversation couldn't be more timely with all the chaos that we have experienced in the markets over the last week. We're going to discuss with Daniel his opinion on the coronavirus crisis, if you will, and what you should be thinking about right now. In addition to the coronavirus discussion, we have a timeless but still applicable discussion around financial psychology. He explains why he himself with all of his experience and knowledge still works with a financial advisor, also why it's not about finding the best financial strategy, but the one that you can live with and why invest in what you know is profoundly dumb advice, wrapping it up with even why Daniel decided to pay off his home mortgage in this low-interest-rate environment and so much more.

But before we get started, I want to share with you an awesome gift from Daniel. He has provided us with a whole box of his latest book, The Behavioral Investor, and we are going to give them away until they're all gone. All you have to do to claim your copy is write an honest review for the podcast, send us an email with your iTunes username, and you can do that right within the podcast app or visit RetireWithPurpose.com/Podcast. After you leave your review, just email us at [email protected] to claim your free book. With that, it's time to dive into a conversation I've been looking forward to for a long time.

[INTERVIEW]

Casey Weade: Daniel, welcome to the podcast.

Dr. Daniel Crosby: Thank you so much for having me on this crazy week.

Casey Weade: Man, I'm so excited to have you here. It couldn't be better timing but I have been looking forward to this interview for a long time and I've followed you for a long time of listening your podcasts, read your books, and I'm just a huge fan. And last time we hopped on, we ended up having some connection issues. So, thank goodness that happened, I think, because now we're able to have a really timely conversation. As you and I sit here, the market’s down. I think I've seen the Dow down around 9.2%, the VIX or fear index as some refer to it as is at a 66 right now. So, man, there's just fear and panic in the streets. We couldn't have a more pointed conversation with a better person that's a behavioral finance expert.

Dr. Daniel Crosby: Yeah. It was meant to be. The technical glitch was meant to be so this timing could work out perfectly.

Casey Weade: Well, I feel like we just got to get right to the point. So, people are wondering, is this the next 2008? Is the coronavirus going to have as big of an impact on the economy as some believe it to be?

Dr. Daniel Crosby: Yeah. So, the only sensible answer to that is I have no idea. I wrote an article this morning called Into the Unknown and I took the title from Frozen 2 because I'm a father of young children and I just watched Frozen 2 on a loop as it turns out, and that's the name of one of the songs. I talked about “I don't know” as sort of the most underutilized phrase in investing and I talked about some of the reasons why humankind is so uncomfortable with uncertainty. And in fact, we prefer a negative known to an unknown. And so, there's so many unknowns about coronavirus or COVID-19 right now. There are so many unknowns about the presidential election, the business impact of this virus. And all of this uncertainty like all of this uncertainty is even worse than the certainty of something negative. There was a stat I saw just this week that said that airline bookings were down 30% in the wake of 9/11 but they were down 70% due to fears of the coronavirus. And again, it's the difference between a horrible cataclysmic known, the known evil of 9/11 versus just not knowing what's going to happen with coronavirus.

So, yeah, I have no idea what's going to happen, and neither does anyone else. And anyone that tells you exactly what's going to happen is trying to sell you something. But the good news, I mean, the good news is though that there are still things that we can do even in the face of uncertainty. But that's what's driving these spectacular down days is just uncertainty which is humankind's biggest enemy.

Casey Weade: And I think one of the interesting things about you, Daniel, is that you're not only a behavioral finance expert, but you're also a pretty well-known money manager at the same time, very invested in that part of the markets and you have a high level of knowledge when it comes to managing money. And yet you still work with a financial advisor or portfolio manager, someone that helps you oversee some of your biases that might come into play if you're just managing things on your own. So, I'm kind of curious to see what are you hearing from your financial advisor and what are you telling your clients?

Dr. Daniel Crosby: Yeah. So, one of the things that's important to understand, my latest book’s called The Behavioral Investor and one of the tricks to becoming a behavioral investor or sort of a psychologically-informed investor is understanding that you're no better or no different than the next person. So, there's this tendency among humankind to think we're better or different than other people and it takes a couple of very specific forms. We think we are smarter than other people, we think that we're luckier than other people, and we think that we're more able to predict the future than other people. Those are sort of these three specific manifestations of overconfidence. And so, you see how it gets problematic at a time like this when people know, like, yeah, I've been getting texts all week from friends and people who are concerned saying, "Should I go to cash? Should I sell out of my 401(k)? Should I do whatever?” And it's like you know you're not supposed to do that. You know that that's bad advice. But yet people think that the rules don't apply to them. They know that that's bad advice, generally.

So, yeah, the reason why I work with a financial professional to manage my money is because I know that having written three books on behavioral finance, having some knowledge of how markets work, having eight years of college and studying human behavior, none of those things makes me different than the next person when it comes to my own money. So, I just think it's crucial. It's crucial, crucial for people to work with someone who can be that outside view because, at times like this, we are also scared. Like, we are also scared and it takes that outside perspective to really get someone to give you some clarity of thought around how you should proceed and how you should move forward.

Casey Weade: Yeah. I wonder we've heard this before. I'm sure you've heard this before from clients where someone will say, “Well, I predicted the last time. In 2008 before everything, I saw it coming. I moved to cash.” And now with this happening again, what's the danger in thinking, “Yeah, well, we predicted the last time. We can do this again.”

Dr. Daniel Crosby: Yes. There’s a couple of dangers there. The first one is that as I've written about in my book, people massively, massively misremember their trading decisions. In fact, in my research, I found that it was “indistinguishable from zero” like people's memories of how they had done and how they had to actually done had effectively no basis in fact. So, people tend to remember all their best trades, they tend to forget all their worst trades. And so, be very, very cautious whenever you are talking to someone at a party or a friend, and they tell you that they timed every turn of the market, because people really, really dramatically misremember. There's something called rosy retrospection where people sort of remember what they want to remember and that's very much at play here. The second thing to remember here is there's people saying, okay, I've seen people online in the past couple of days, say, “Oh, well, I went to cash, whatever, three weeks ago or whenever the perfect time was,” even if that's the case, and it very seldom is, even if that's the case, every decision has a counter decision.

And so, for everyone who timed the market perfectly, they've got to then time their re-entry into the market perfectly and that's very, very hard to do. And in fact, William Sharpe, who won a Nobel Prize for his research into markets found that you had to get your buy and sell decisions right 82% of the time or better to match just buying and holding. So, if you want to beat someone who's just doing nothing, you've got to get more than four out of five buy and sell decisions right and I'll tell you that nearly no one can do that. So, there's just a lot there like everyone misremembers these things. You got to get it right on both ends and just most people don't.

Casey Weade: That kind of takes me to a place that I didn't think we would go here quite yet but it takes me to this place where I'll have younger individuals. You being a younger guy, you've probably got friends that are in their 30s or maybe even in their 20s and even I take this as far as people in their 40s. Just younger individuals that are long ways from retirement, they'll say, “Hey, can you manage my money?” And, yeah, we could do that but you don't necessarily need me. If it's true that there's a defined sliver of those individuals that can time the market and usually, they end up falling on their face eventually. And it's better that they just buy and hold the index, the S&P 500 index fund or whatever. I'll say, “You don't need me. If your goal is just growth, then just keep your costs low and dollar cost average into an index portfolio and I'll see you in 30 years,” because there becomes this shift when we enter retirement where it's no longer about growth. Now, it's about preservation and distribution. Our goals shift to risk management. I feel like people should only be working with a financial planner to mitigate risks, whether that's market risk or tax risk or whether that's healthcare risk, whatever it is, and I just like to hear your take on them.

Dr. Daniel Crosby: So, I think a little bit of a different take. So, your assumption there assumes that these people can behave themselves and I have very little faith in that. So, yes, if you have massive willpower, if all you're looking for is capital appreciation and you are the most disciplined saver and investor in the world, you could do a lot worse than indexing into a multi-asset class portfolio, not touching it for 30 years and then calling someone like you when you need the accumulation strategies and insurance and things like that. But Morgan Housel, a gifted writer, and investment thinker, he has this framework that is totally, by the way, not based in fact, but is totally consistent with my anecdotal experience. And he says, in his observation, 10% of people really can stay the course like without any help.10% of people in the world can just do what it takes to be long-term buy and hold investors and not be shaken out by markets like this. 10% of people are degenerate gamblers, right? Like 10% of people are helpless, even with the most comprehensive, most sound financial advice. They're just immune to good advice and they're just destined for stupid decisions.

And then the 80% in the middle, though, is 80% of people in the middle can be okay if they have someone to hold their hand. So, I have sort of a framework for what I think it takes to reach your financial goals and it's these three Es and it's education, environment, and encouragement. So, the education is just what it sounds like. You need to know how markets work. You need to know the difference between a mutual fund and an ETF and you need to know about fees and diversification. You just need to know about the nuts and bolts of investing. The environment is the portfolio itself like you need a portfolio that is consistent with your risk tolerance levels, your risk capacity. The optimal portfolio is not the one that shoots the lights out, necessarily. It's the one on which you can take the ride so you need the right environment. But then that third one is really where an advisor comes in, just that just-in-time encouragement. So, in a week like this, I would say to you that even the best-educated investors, they’re like me. So me, I'll use myself, well-educated with respect to these things, have a portfolio that is optimized both for growth and for behavioral considerations. And still, when I checked my account this morning, it's brutal. Like I mean, it's tough. It's tough to look at and you need someone to remind you while you're there. You need somebody to keep you on the path.

And so, I'm with Morgan, that I think 80% of people can get there with the right help, 10% of people there's kind of no helping, and that it's a very, very small minority of people that can do it themselves. And I'll say this further, another complicating factor is, if you think you're in that top 10%, you're probably not like it's sort of a weird paradox that if you're very confident that you're the one that could stay the course and could make it through, you're probably overconfident. And so, weirdly, I think the 10% that could actually do it themselves are humble enough that they might not even recognize that in themselves. So, it's sort of a weird paradox.

Casey Weade: No. I absolutely love that response and that was my biggest takeaway from your interview with my good friend, Brad Johnson, on the Elite Advisor Blueprint Podcast, as you say your exact words during that interview where it's not about the best financial strategy, but the one you can live with. And I thought there's so much depth to that because if we hop online and we take an academic approach, you can hop out there, you can take a very academic approach, and I think in your discussion with Brad, you were talking about annuities and you said, “Hey, annuities aren't for me but it doesn't mean there isn't somebody out there that they're right for because it allows them to live better. It allows them to experience life in a different way.”

Dr. Daniel Crosby: Right.

Casey Weade: My question would be in that regard, how do you know which person you are? I mean, I know for me, I'm somebody that's about 80% fixed. It's mostly insurance and real estate. I have my 401(k) in the market, but I know I can't touch it for 40 years so who cares? I'll just leave it alone. But I don't know that there are very many individuals out there that actually know what they can live with. They think they're in that 10%, right?

Dr. Daniel Crosby: Yeah. Well, there's really two things that are at your disposal. So, one is a formal, valid, reliable measure of risk tolerance, which there aren't a whole lot. But even those have big limitations. Those have big, big limitations. So, the best predictor of future behavior is past behavior. I mean, the best thing you can do to determine how you're going to act during the next financial panic is just to look at how you acted during the last financial panic. And there's all these people who come to me and say, "Look, I panicked in 2008 and 2009 but now I know better. The next time there's a big crash, I'm going to be in there buying with both hands.” And I say to them, respectfully, "No, you're not,” like you know what I mean? Like, no, you're not, because that's who you are. And that's fine like you're the type of person who panics when things get like this. There's no shame in that. Just know that about yourself and make allocations accordingly. So, the best thing that you can do is just look at what you've done. I mean, I know that's not brain surgery but psychology is not physics.

All we have is things like this, that what you've done in the past is what you're going to tend to do in the future. And so, I hope that people will take a good long hard look at themselves, and like, how are you reacting this week? Like, what have you done this week? And that's going to tell you, and if you're freaking out going back to that second E, your environment’s off, your environment meaning your portfolio is not where it needs to be because if you're freaking out, something's amiss.

Casey Weade: Well, and then that also depends on your circumstances. I mean, if your circumstances are different today than they were back in 2008, maybe back from 2007 to 2009, you were still working, you had 10, 15 years until retirement, but now you're making this transition to retirement, you're already in retirement. Now, I think it's difficult for individuals to change their way of thinking during those major shifts in their life stage because they might look back and go, "Yeah, it didn't scare me back then. I'll be fine this next time.”

Dr. Daniel Crosby: Yeah. No, that's a great point. So, I mean, with respect to that, in some ways, you never walk through the same river twice because I think about where I was in 2008, 2009 I had just graduated from – I had just gotten my Ph.D. I was just sort of entering the workforce and I didn't have very much money. So, the market crashing was sort of a theoretical exercise for me. It was like, “Okay.” So, my $5,000 is now $3,000 but like whatever. It's not a big deal. It's very different now. I mean, it's very different 10 years on. And so yeah, I think in that respect, the context matters a lot. Again, I think that's where again, 80% of people need an advisor because a 65-year-old taking a 30% hit and a 40-year-old taking that 30% hit are very, very different calculations.

Casey Weade: Yeah. Well, but even for those that say, "Well, I've got an advisor,” and then they make those phone calls. They talk to their advisor and quite often you've been in the position. I've been in the position where you just can't talk somebody off the ledge right there. They are going to liquidate today and they're not going to get back in until the markets already rebounded. You just already know that this is what the result is going to be. So, what should an advisor be saying to a client during those periods of time specifically to try to help them stay the course?

Dr. Daniel Crosby: Yeah. So, I think there's a couple of things that advisors need to think about at times like this. First of all, is having empathy. Empathy is so important because advisors are so steeped in this. They have such a deep knowledge of markets and the fact that this just happens. I mean, stuff like this just happens every couple of years. They've lived through many of them in many cases and they just don't tend to panic. But the fact that that's the case can lead them to be unsympathetic with the very real fears of clients and to sort of chalk this up to irrational behavior. So, the first thing I think is to empathize with and even own the fact that you’re like, "Yeah, this is scary,” and I mean, you can say that without justifying bad behavior. You can feel that fear without having to liquidate but I sort of tell advisors to take the following approach. I have advisors take a why, what, who, how approach, which is to say first focus on the why. Get them re-centered on their purpose, their goals, like why did they come to you?

If the plan hasn't changed, right, if the plan hasn't changed, and the goals haven't changed, neither should your execution on that plan. And so, unless the goals have changed that why is intact and people I think can get disconnected from their why at a time like this and it can start to seem just like video games like numbers on a screen and not money that's funding a very real-life concerns. So, re-centering on that plan or that why is big. The what is sort of the educational piece. For instance, the market has on average dropped about 15% peak to trough every single year for the last 40 years, and yet every time the market drops 10%, there's markets and turmoil specials. Everyone acts like it's the end of the world. We act like we've never seen this before. Like, we need to educate our clients as to how markets work. If you look at the 1900s, you had world war after world war, tyrannical dictators flew wiping out large swaths of the population. I mean, you had a million terrible, violent, scary things, and very volatile markets and yet over that time, the markets compounded wealth at a very dramatic clip. So, this is just kind of how it works.

But people don't understand that. The average person doesn't understand that. So, the what after we've re-centered them on that why, we have to educate them with the what of just like this is how markets work. The who is rooting that in sort of an evidence-based theoretical model. You have to tell them basically who agrees with you because you are, after all, just one person. But the workaround diversification and multi-asset class investing, that's Nobel Prize-winning work. The workaround behavioral finance, that's Nobel Prize-winning work. You need to couch your advice in sort of a larger tradition. And then the how is you need to give them something to work on. So, at times like this, we have a profound action bias, which is when everything's on the line, when we see our portfolio dropping every day, we have a profound bias to take action. And yet, we know that in every country that we've ever studied, there's 19 different countries where they've looked at this, the more people meddle with their portfolios, the worst they tend to do. That's true in every single country that we've ever studied.

And so, we have this action bias that's natural. We feel like panicking. We want to fight or flee. But we also know from the research that doing something is exactly the wrong thing. So, I think advisors have to offer replacement behaviors. You have to give them something to do that's not the wrong thing. That could be reading an article or a book to deepen their understanding of the markets. That could be laughing in the face of fear and ramping up your 529 contributions. That could be going for a run. I mean, that could be 100 things, but we have to offer them replacement behaviors that speak to this action bias when people have an understandable need to want to do something. So, that's kind of my model.

Casey Weade: Well, and we can take those steps. I've taken similar steps that have still ended not with the result that it was best for the client, right? They're still going to liquidate or freak out. And I wonder what your thoughts are on this. As far as, one, we can take this approach of education environment encouragement, we can take this discretionary approach as behavioral finance approach, and then we can take a more structural approach. And I like the thought of combining the two. And when I say structural, I'm saying most of the families we work with, for instance, are in retirement, right? They're transitioning, already in retirement, and the reason they're going to panic is different today than it was 30 or 40 years ago, when they were kids. Yeah, now they're going to panic because they're afraid they won't have money for emergencies, they won't have money for income for the rest of their lives, they won't have funds to leave behind to their kids or they have a major healthcare crisis so are they going to have the funds to be able to solve those things?

So, instead of that, let's piece this apart to, hey, we've already secured the funds you need for liquidity, your income, and health care, legacy money, everything that's left as long term growth money. It's for inflation protection. It's for long-term growth. So, this is essentially making you younger. For me, when I think of my financial life, it's a lot easier for me to endure things like this when I know I don't need my 401(k) for an extended period of time, 20, 30, 40 years, whatever it might be, and I know that everything I need from an emergency standpoint, health care, all those things are taken care of. And I just wonder what your thoughts are on kind of creating a structure and if you have created any structure like that for the families you work with.

Dr. Daniel Crosby: Yeah. So, the number one rule that applies, you brought it up earlier, is without me speaking for or against any specific investment product and getting yelled at my compliance department, the number one thing you can do is to buy yourself enough peace of mind that you can stick with your plan. So, I'll give you a personal example. So, my wife and I just chose to pay off our house. Now, why in the world would you pay off a house at a time when you can get, whatever, a 2.8% mortgage.

Casey Weade: We’re refinancing right now for a 30-year three and a quarter.

Dr. Daniel Crosby: Yeah, like in some ways it makes no mathematical sense, but it makes psychological sense for us because the fact that our house is paid for is just a mental anchor for us to go, "Okay. I'm never going to live on the street.” You're just kind of taking the worst-case scenario off the table. So, could I do better than that? Could I have taken that money I used to pay off my house. And if I were a perfectly rational investor, put that in the market and do better than 3% a year over the next whatever, 10 or 20 years? Yeah, probably. But for me, it made sense because it gives me the peace of mind I need to put other capital at risk and to take appropriate risk with the rest of my capital. So, whether you do that through insurance products, whether you do that through paying down debt, whether you do that through equity or real estate exposure, the principle is the same, that you need to understand yourself deeply enough to know your quirks, to know your fears to take those off the table to the extent possible to allow you to take appropriate risk with some of your remaining capital.

Casey Weade: Well, I think that's really hard for some people. It's something that's really easy to say and for many, it's just not easy to do. Because, as you talked about in your book, there's this thing called risk addiction that we kind of get addicted to this risk. And in many families we work with, they say, “Yeah, but it's better that I invest that money in the market,” or, “I want to make 10% 12% per year.” Well, you only need to make 2% or 3% so why are we going for 10% to 12% when we know that's going to make you uncomfortable? And you kind of noted this as the devil that we know, in the book. So, can you just expand on that a little bit and how it relates to this topic?

Dr. Daniel Crosby: Yeah. So, people when they're thinking about risk tend to be kind of binary. There's a group of people when you say the word risk, there's a group of people who think what could I lose and there's a group of people who think what can I gain? And never between shall meet. And so, if you are in the second group that in the sort of what can I gain group, you're always trying to put capital at risk to try and maximize upside. And that's something that's not very sensible to do if you don't need to take much risk to, like you said, try and get by. So, the perfect example of this is Sir Isaac Newton. So, this is a guy, one of the smartest people that ever lived. He's very rich. He has all his financial needs met, but he sees his friends who have invested in the South Sea company getting richer than he is. And so, he takes the entirety of his wealth. The man has all the money he can ever spend, all the money he'll ever need to live. But he takes that all because he needs to beat his friends. He needs to hit a number. He needs to be better than the next guy. And he invests everything he has in the South Sea company right before it goes to zero.

And so, he says, “I can calculate the movement of the stars but not the madness of men.” And this is what people who are addicted to risk do like this is not a game. Every developed market in the world has had drawdowns of on the magnitude of 70%, 75% like these are developed good countries too. So, the reason why equity markets, in particular, have tended to compound wealth so nicely is precisely because they're risky. Like there is a relationship between risk and reward in get rich quick and get poor quick are sides of the same coin. So, people need to think and really understand this relationship between risk and reward, and only take the risk that they can take behaviorally and only take the risk that's necessary to reach their goals.

[ANNOUNCEMENT]

Casey Weade: Hey, sorry for the interruption. It's Casey and I know you're listening to the Retire With Purpose Podcast because you want to maximize your financial efficiency and plan for retirement that’s filled with meaning and purpose. So, I've got something for you. If you want to take this a step further, I want you to head on over to RetireWithPurpose.com and sign up for Weekend Reading for Retirees. This is a collection of handpicked articles with commentary from myself sent every Friday straight to your inbox. Sign up and I'll send you an email right away containing one of my favorite recent podcasts interviews with insights into my biggest takeaways. Second, I want to share one of my favorite articles featured in my Weekend Reading for Retirees along with commentary and an e-book copy of my best-selling book, Job Optional. I want to provide you with the best of the best resources of what we have here at Howard Bailey to offer and we've made it easy to get started right now. Again, all you need to do is go to RetireWithPurpose.com, sign up for a Weekend Reading for Retirees and we will help get you on track to living a secure retirement that's filled with meaning and purpose today.

[INTERVIEW]

Casey Weade: When someone says, "Is the stock market really risky?” and I read an article recently, I believe on Seeking Alpha talking about the stock market's history averaging something like 10%, well beating inflation over any given whatever is 10-year period or whatever they said, and then comparing that to bonds, the aggregate bond market. There are extended periods of time throughout history where they haven't beat inflation. And they said, well, is that really risky if historically, it's performed really well and the market always recovers?

Dr. Daniel Crosby: Yeah. So, it's all about timelines but then this is where we have to draw the distinction between what economists call homo economicus which is sort of this idea of a perfectly rational economic man or economic person, and then homo sapiens, like each of us. So, in a vacuum, if behavior’s not an issue, the market is not that risky on a long enough term. If you look at any 30-year rolling history, the US market pick any rolling 30-year period in history, it's been great. Like I mean, absolutely great. So, when you think about the average investors investment lifetime of call it 30 years, pick any 30 years. It's somewhere between really good and outstanding. If you can dollar cost average buy and hold for 30 years, and keep a 30-year mindset, that's in a vacuum, though. That's all theoretical because nobody thinks that way. I mean, we're here. I mean, I don't know what the market’s doing right this second but we're here where the market’s down something like 25% in the last two weeks, and I promise you, there are very, very few people who are totally cool with that and just going, "Oh, well. We'll get them next decade.”

I mean, that's like, yeah, is the market risky over a 30-year horizon? No, not really. But is it risky for people who from moment to moment make panic decisions and can freak out and buy and sell at the wrong times? Yeah, I mean, the lived experience of investors says that the market can be risky, because we have a hard time managing those behaviors. So, it's an important distinction to make between sort of the mathematical, sterile abstractions about the market, and then how the market feels minute to minute, because the market feels very risky right now, even though I could say with a very high degree of certainty that whatever you've lost over the last few weeks, you will have back in 10 or 20 years with lots to spare. I mean, I could say that very, very easily and yet it doesn't feel that way today. It's true, but it doesn't feel true and that's an important distinction to make.

Casey Weade: We think of behavioral finance as I think you kind of think about all these emotions, all these biases, etcetera. It's all negative. All this stuff is bad. I just need to take emotion out of investing completely. It shouldn't be present. It's not helpful when it comes to investing to have any emotion whatsoever. Is that true? Or are there times where emotions can be used for good in the investing world?

Dr. Daniel Crosby: Yeah. So, anytime you can take one of these behavioral tendencies and kind of flip it on its head, it's powerful because we are emotional creatures full stop. When you look at people who have had the emotional processing centers of their brain-damaged, people who have traumatic brain injuries, where they can't really process emotion, they have trouble making even mundane decisions. They have a hard time doing things like picking out which flavor of ice cream they want or picking out if they want to wear a gray suit or a blue suit. So, emotion whether we understand it or not, there's undercurrents of emotion in every single decision that we make. So, yeah, it's not very realistic to say, “Well, I just won't be emotional about my money,” because research has also shown that we are more emotional about money than anything else. When they look at brain reactivity, they'll show people pictures of nudity, right? So, they'll show people pictures of like attractive people nude. They'll show people pictures of violence and death. And then they'll show people pictures that activate sort of greed and money, you get more brain reactivity out of money than you do beautiful people or fear of death or anything else. We are uniquely emotional about money.

So, to answer your question, being excessively emotional about money leads us to make bad decisions, but we can actually turn that on its head and we can get emotional about reaching our goals. So, to give an example, people who looked at a picture of their children before making a financial decision, in one study, saved more than twice as much as a control group. So, they got emotional about their kid like that's not rational. It's not rational in the strictest sense that you should look at a picture of someone you love and then save and invest better. But we'll take it, right, like I'll take it. So, this is where I get back to that re-centering on why because we can use emotions to say, “You know what, the market may be scary right now, things may be scary, but I'm not going to let it get in the way of reaching this goal or sending this kid to college or retiring with my spouse or whatever it is.” So, that kind of emotion can be good to kind of like, “Oh my gosh, the sky is falling,” emotion, though, is almost always, always wrong.

Casey Weade: Well, it's kind of wrong in a very unhealthy way too not just damaging for your finances and reaching your investment goals or your financial goals, but it can also be very, it can have a strong effect on your health. And we talked a little bit about that in your book. And so, I just wonder for those individuals that are maybe taking an academic approach, but periods of time like this, let's say we're going through this period of time, the last couple of weeks have just been really stressful. What kind of impact is that going to have on their longevity, on their health? And should that direct them to say, “Okay, if this is the level of stress is causing, maybe I do need a different strategy.”

Dr. Daniel Crosby: Yeah, for sure. I mean, one of the things that the whole coronavirus conversation has put into perspective, I think, this current situation is unique because if you look at 2008, people were worried about the solvency of the American banking system, which was a legit worry at the time, but they weren't worried about their health. Right now, people are worried about their health. They're worried about the health of their loved ones as well as how that impacts their pocketbook. So, let right now be an example of how sharply this puts things in perspective, like money isn't everything. And if your financial life is taking years off your life through stress and worry, and depression and anxiety, then it's time for a new plan. I mean, it's absolutely time for a new plan because you can't take it with you. I mean, you cannot take it with you. Money is good. Money is what psychologists call a hygiene factor. So, to sort of explain, the absence of a hygiene factor can make you miserable but a lot of a hygiene factor won't make you happy. And so, that's true about money.

If you have no money, life is very hard. You can't eat. You can't send your kids to a safe school. You can't have appropriate shelter. You can't just reach the basics of life. But once you reach a plateau and research shows that we plateau around $75,000 a year in annual income, once you have enough money to eat healthy food and sleep in a warm bed, having more money doesn't make you any happier. It just totally falls off. And so, I think times like this help put money in appropriate context. Let money serve you but don't let it become your master. Don't let money become your master. Don't let the pursuit or this addiction of risk lead you to a life and a series of worries that take money out of its appropriate context. Because none of us gets out of here alive and none of us can take money with us. So, let it work for you and not against you.

Casey Weade: Well, I think that is a good segue into looking forward, say six months, 12 months. Yeah, eventually, as you said, we get through this. It doesn't last forever. Eventually, there's a recovery. Eventually, we're back on the next bull market. Maybe it's six months, 12 months, whatever it is. We know what we should be doing or saying to clients before a time like this or especially during a time like this, but what do we say after? How do we use this experience and leverage this experience to improve the lifetime of the experience that the client’s going to have? What kind of coaching should we be doing on the back end of the bear market?

Dr. Daniel Crosby: Yeah. It's a great question. So, there's actually two ways that we can approach this. We could do what psychologists – a lot of people know what a postmortem is, right? So, you could look at whenever this shakes out, whatever the eventual outcome is, you can look back at this and say, okay, like, what did we learn? Like, how are we allocated? What were the gaps in your knowledge? What were your gaps in your knowledge that that may have led you to freak out unduly? How are we allocated or misallocated? What changes do we need to make there? How can I better support you? What was your level of personal preparation? One of the things that I think has been exposed during this whole coronavirus conversation is the preponderance of medication that we take here in the US is manufactured in China. So, when there's supply chain disruptions in China, for those who are ill-prepared, there's very real consequences here in America. So, what's even the level of personal preparation that's appropriate in terms of having a rainy day fund or a little extra food or a little extra medication, whatever that is?

So, there's a lot of, I think, natural conversations that flow from a bear market but we can also do a premortem. I mean, even in call it peacetime, we can take clients who have never experienced a bad market, and we can look at their portfolio and say, “Look, if something were to fail here, what would it be? If we get 30 years from now and you haven't reached your financial goals, what are the reasons? Is it because you had inadequate protection and then something terrible happened? Was it because you didn't take enough risk in the markets and you weren't able to compound your wealth in a way that kept up with inflation? Is it because you were so freaked out that it threw you off course?” So, I think that premortem, I mean, we find ourselves in a bit of a warzone right now, but I think that premortem concept is another one that's powerful because I think a lot of people can determine that single point of failure if you go through that exercise with them.

I live in Atlanta. There's not a lot of Fortune 500 companies here and there's a lot of people walking around with concentrated positions in, whatever, Coke or Aflac or UPS and the different firms that are based here. And you talk with someone who has 80% of their wealth in Coke stock because they feel loyal to coke and coke gave them a shot out of college or whatever. You go, “Look, you've got $2 million. 80% of it's in Coke stock. If this thing goes wrong, where do you think it goes wrong?” And they'll go, "Well, maybe I'm a little overweight Coke stock,” and you go, “Yeah, I think you are.” So, I think the premortem, you don't have to wait for a disaster, right? Like it's a good thing to do a postmortem but I think you don't have to wait for ugly times such as these to have a meaningful conversation about what to do next.

Casey Weade: Well, talking about somebody that works for Coke, they love Coke, they're involved in it. That sounds like Peter Lynch's “invest in what you know” and you mentioned that is profoundly dumb advice.

Dr. Daniel Crosby: Well, yeah, we'll use the example the not at all theoretical example. I know a number of people like this. I have someone who lives in Atlanta, works for Coke, and has the preponderance of their wealth in Coke stock. The reason that it's a dumb idea, think about how many risk elements are loading on the same single point of failure, right? So, if Coca-Cola falls upon hard times, people stopped drinking sugary drinks. And so, Coke stock suffers. What do they do? Well, they fire a percentage of their workforce, which means your job might be on the line. The stock goes down. So, now your holdings are falling just as you're losing your job. And where's your house? Your house is in Atlanta. It's 10 miles from the office and so now your real estate's worthless. And so, if you look at the US, and I mean, this is true everywhere. We'll pick on the US because that's where we're from. If you look at the US, people in the Midwest tend to be overweight, agricultural stocks. People in the northeast tend to be overweight financials. Like, people tend to buy what they know, thinking that it's a safe bet, because thinking that they have some sort of increased competence around it or increased understanding of it. But in fact, they're double and triple loading risks onto a single point of failure.

And so, it's interesting for me as someone who works in finance to think about this because again, like as the market drops, our holdings drop, our jobs become more precarious. There's too much risk on a single point of failure. So, buying what you know tends to be very risky. And buying what you don't know, in terms of having exposure to asset classes and parts of the world that you're less familiar with, tends to be very good advice.

Casey Weade: Right. I don't know if you find this, but I often find that business owners are the worst violators here. They are the ones that are the most guilty, especially small, medium-sized business owners where it seems like we're often taught I've got a friend that said this well, "You got to put everything back in your business for the first five years,” or, "Hey, where do you get the biggest returns? We get the biggest returns in your own business. So, put all your money back into your business.” And it just wasn't something that dad taught me growing up. He said, "Your business is like owning one individual stock and you need to continually try to diversify that and create your own financial stability elsewhere.”

Dr. Daniel Crosby: Well, yeah, your dad was right, as it turns out. So, I mean, here's the tricky thing. If you look at the richest people in the world, almost all of them are rich off a concentrated equity position or business ownership, right?

Casey Weade: Jeff Bezos

Dr. Daniel Crosby: Yeah. Jeff Bezos, Mark Zuckerberg, any of these folks are rich off of concentrated ownership of a single equity. But like I said earlier, get rich quick and get poor quick are sides of the same coin. And so, you have to, if you're going to be a behavioral investor, you have to play the probabilities and the probabilities about business ownership are grim like most businesses fail, most businesses fail rather fast. And so, what you're doing when you invest in a mutual fund or an index fund is you’re owning little pieces of everyone else's business, knowing that you're then diversifying, because if you are pumping everything back into your own business, you may be the next Jeff Bezos, but probably not. And probabilistically speaking, you're much more likely to fall on financial hard times, than you are to be uber-wealthy. So, I'm an entrepreneur at heart. I respect and love entrepreneurs and small business owners but I think one of the things that they can do is to diversify away from that by investing in other asset classes and by ownership in companies outside of their own because you're already concentrated, right? I mean, you're already concentrated if you're running a business. You can, at least at the margins, reduce your exposure to that concentration risk by investing in other sorts of markets.

Casey Weade: Yeah. And I don't know why this is, but it seems like a lot of business owners tend to manage their own stock portfolio outside of the business. And you talked a little bit about the dangers of individual stock investing for the novice and I often find that those individual stock investors, they're following some type of investment newsletter or something along those lines. Can you just speak to that?

Dr. Daniel Crosby: Well, if you think about the kind of personality that leads you to take on an entrepreneurial venture, you're already like on the right end of the risk curve, right? You're on the right tail of the risk curve. Because anyone who looks at the probabilities, if you just mathematically look at opening a business or starting a restaurant or whatever, it's a dumb idea, like always 100% of the time. Mathematically, it's a bad idea. It's always a bad idea to start a business. So, business owners and small business owners and thank goodness we have them and thank goodness there are people who ignore the risks and ignore the math, small business owners are people that look at that math and they laugh at it and they go, “Well, I'm different. I'm different. Yeah, I know most people fail at this, but I'm going to succeed where most other people have failed.” So, the average small business owner I think you could say with some degree of certainty is more risk-seeking than average and probably more egotistical than average. It takes a level of overconfidence to look at those statistics and go, "But yeah, that doesn't apply to me.”

And so, yeah, it makes perfect sense to me, that small business owners would want to manage their own money. But I think it's important to remember there's a great book on personal development called What Got You Here Won't Get You There. And I think that the skills required to build and maintain a business and the skills required to build and maintain a portfolio have very little in common. And so, I think that God bless small business owners, I'm glad they exist. I'm glad they take risks to put our economy to work but there are different considerations and I hope small business owners will consider that.

Casey Weade: Well, what if you are one of those people that actually really enjoys managing your portfolio? You know those folks so there's one that always comes to my mind. I mean, he was CPA. We met years ago and he would go, he said, “I love managing my own money. I don't plan on handing this over to anybody.” He just loved managing those money. So, he was logged into his brokerage account for roughly two hours a day. He watched CNBC and Bloomberg and Fox Business and he just loved it. And he didn't really necessarily want to have anybody else manage the portfolio. I mean, what kind of guidance would you give to somebody like that?

Dr. Daniel Crosby: So, I would just say to be clear-eyed about it because if you love this stuff, I mean knock yourself out. Who am I to tell you that you need help if you don't? But I would harken back to this stat about how wildly people misremember things. I had a friend call me a couple of years ago, sort of at the height of the bull market, and this friend worked outside of finance but was managing her own portfolio and she said, “Hey, I think I want to be an investment manager. Like, I think I want to be a portfolio manager because I'm just absolutely killing it in my retail account.” And I was like, “Whoa, really? Tell me what you're doing.” And she didn't have much of a process and she goes, “Well, why don't you take a look at my returns?” And I looked at her returns and she had done well, but she had done worse than the benchmark. I mean, she'd done worse than the market broadly. It was just a good market

And so, again, like people don't account for a rising tide lifting all ships. People don't account for the times when they screwed up. They tend to write those things off and just remember the best things. So, if you're managing your own money, it's absolutely enjoyable to you and you're keeping pace within an appropriate benchmark, why would you turn it over to anyone else? But I think those people are relatively few and far between if they are honest, and if they take a good hard look at their performance.

Casey Weade: Now, what would you say the individual investor, let's say they have an individual stock portfolio and you talk a little bit about the number of stocks that you need in order to be truly diversified. And I think that number of stocks is much smaller than most people believe it is. How many stocks do we need in an individual portfolio? And should we even be trading individual stocks? Why not just put it into say some ETF mutual funds?

Dr. Daniel Crosby: Yeah. So, again, for the average investor, you have no business trading individual stocks. So, let me say this. I know lots of people who keep 3% to 5% of their investable wealth in individual stocks because when a cool company comes around or a company that they love to patronize, they want to feel like they have ownership in that, that's fine. But with your real money, I mean with the bulk of your equity exposure, the average person has absolutely no business trying to research and determine which stocks they should hold an individual stock portfolio. Now, if you love this, and this is your thing, mathematically, you only need about 25 or 30 stocks to get a level of diversification that looks not perfectly like but a whole lot like something like the S&P 500. I mean, you have only to look at the Dow which is 30 stocks, and the S&P 500 which is whatever it is now, 503 stocks. They're going to mirror each other fairly closely even though one has 30 stocks and one has 500. The same is true if you're randomly picking 30 stocks true on average if you're randomly picking 30 stocks, but for the average person again, we were way, way better off owning an ETF or a mutual fund. You're better off still just working with an advisor and helping them to help you.

Casey Weade: Yeah. And it brings me to a question I had for you on the number of stocks inside of ETFs and mutual funds. We’ll audit some of these portfolios. People will come in with three or four different advisors. And all of these advisors have them in different mutual funds. They feel like they're diversified. They own thousands of different positions. And sometimes we go, "Well, I'm diversified then.” Is there a danger to overdiversification?

Dr. Daniel Crosby: Well, I think there's just misunderstanding around diversification. I think that sometimes people will come in, I'll see portfolios that have a bunch of different ETFs or a bunch of different mutual funds, but they're all sort of some different twist on large-cap US stocks. And so, you could own 10 different mutual funds. There's like 10,000 mutual funds now and something like 10,000 hedge funds and we're getting there with ETFs. So, I mean, you could own 10 different mutual funds, which feels diversified, but they may not look much different from each other at all. Similarly, I see people will sometimes want to work with two financial advisors and they go, “I want to work with two financial advisors so I'm diversified,” and I’m like, "What? There's no guarantee of diversification by spreading your money between two different people who may be doing the very same thing with it.”

So, you have to understand you need diversification within and between asset classes. So, you need within your fixed income or your equity or whatever you need the appropriate number of holdings from the appropriate number of sectors to be diversified but then you also need, I'm a big believer in multi-asset class investing. You need to own foreign stocks. You need to own emerging markets developing stocks. You need to own US. You need to own bonds. You need to own all this stuff and so you need that diversification both within each individual asset class and then between them. And that's something that I think people have a hard time grasping sometimes.

Casey Weade: Well, I think you're dead on there. And I know our discussion is coming to a close here but there's one thing that I think would be really valuable for a time period like this. We talked a little bit about and I should have thrown this question back when we talked about what you should do post – I think you said postmortem.

Dr. Daniel Crosby: Yeah.

Casey Weade: So, after we get through the bear market, what should we be doing? And I think one of the things we might be able to recognize now and then after, and this is just a quote that was in your book. You said, “If you check your account daily, you'll experience a loss just over 41% of the time, once every five years 12% of the time.” So, how often should we be checking the status of our investments?

Dr. Daniel Crosby: Yeah. As little as possible I mean is the answer.

Casey Weade: Well, right now we might look at it go, “Well, now we're down 20%,” but in 12 months, we sit here and we've made a full rebound and the lesson is you shouldn't have looked at your portfolio that whole period of time. I don't know.

Dr. Daniel Crosby: Yeah. Well, it's interesting. So, again, I don't know. I'm not looking at the stocks right now. I don't know what's happened in the past couple of minutes because it's been fast-moving. But as of a few days ago, we were up at the three-year mark, the five-year mark, the 10-year mark. Again, it goes back to the way you frame the conversation has everything to do with how scary it seems. If you're looking at it every day, the market is up 59% of the time, 59% of days and down 41% of days. So, there's a slight edge in favor of the market being up more days than down but the tricky thing is if you're looking at it every day, we know from research and behavioral finance that a loss feels twice, two-and-a-half times as painful as a gain feels good. So, that 40%, that 60/40 split, it ends up feeling like the 40% ends up feeling a lot like 100% of the time. It feels like every time you look at it, it's down. You see this. Humankind has a tendency to hang on to negative stuff way more than positive stuff. If research on relationships finds that in a marriage, if you don't have five positive interactions for every one negative interaction, you're going to get divorced.

Like, if you're having one compliment to your spouse for every one fight you're having, you're done. Even three compliments to every one fights you're having because fights hurt worse than compliments feel good and the same is true of our investments. And so, the less you can check it, the better you are. And the longer you can spread those timeframes out, the more smooth it's going to appear to you. So, I know it is very, very hard. I mean, I'll be the first to admit. I've been updating my stocks app by the minute lately, just because it's crazy. I mean, it's just so much going on but the less you can look at it, the better off you'll be for sure.

Casey Weade: Yeah. Well, as we wrap up here, would it be okay, if I close with one philosophical question?

Dr. Daniel Crosby: Of course.

Casey Weade: A little more personal here. Where do you find purpose and meaning in life?

Dr. Daniel Crosby: So, it's interesting. I'll give two answers to this. First is my relationships. I'm married. I have three young kids. Spending time with my wife and kids is just a blissful experience for me. I'm never happier than when I'm doing whatever it is I'm doing with them. So, that's my one answer. My second answer would be in helping other people find their purpose or meaning. Like, I'm a big believer that you just get one life, you got to live it right. Our time here is short. And that this money stuff that we spend all our time talking about is just a conduit to doing bigger, better, more meaningful things. It is money is necessary, but not sufficient to live a good life. And so, I love helping other people discover their meaning and purpose and actually I've been working on a book about this. My next book will not be about finance. My next book will be about meaning and purpose because I think it's a big part of why we see a mental health crisis forming in our country right now. And it's a big part of what's missing in a society that's over-focused on financial wealth and under focused on other types of wealth.

Casey Weade: Well, I love that. It’s beautiful and it's something that's going to make a huge impact in the world. Thank you so much, Daniel, for taking this time to sit with us and being so generous. I truly appreciate it.

Dr. Daniel Crosby: No, my pleasure. It was a great, great conversation.

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