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May 27, 2019 Last updated: June 17, 2019

Podcast #511: Mastering the Psychology of Investing

When it comes to investing, your brain can be your best friend or your worst enemy. My guest today explains how, and what you can do to ensure your brain is a staunch ally in your quest for financial security. His name is Daniel Crosby, he’s a psychologist, behavioral finance expert, and the author of The Behavioral Investor. We begin our conversation discussing the surprising ways sociology and physiology influence our financial decisions. We then delve into the psychological factors that cause us to make bad investing decisions, including ego, conservatism, attention, and emotion. Daniel then walks us through ways you can mitigate those factors in your financial choices. We end our discussion outlining what an investing framework looks like based on principles of behavioral science. 

While the principles discussed in this show relate to making sound choices in the area of financial investing, they’re really relevant to making good decisions of every kind. 

Show Highlights

  • What is behavioral investing?
  • How sociological principles impact our financial decision-making 
  • Why money is a “functional fiction” 
  • How our body and physical well-being influences our financial decisions 
  • Testosterone and financial decisions (and why women are better investors) 
  • How ego affects investing 
  • Why our confidence increases when more complexity is introduced 
  • What is conservatism? 
  • How loss aversion impacts our decision making 
  • Why you should sleep on it 
  • How our attention influences our decisions 
  • Why you shouldn’t be checking your portfolio every day 
  • The HALT Tool 
  • What type of person should get a financial advisor?

Resources/People/Articles Mentioned in Podcast

Connect With Daniel

Standard Deviations podcast

Daniel on Twitter

Daniel on LinkedIn

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Read the Transcript

Brett McKay: Welcome to another edition of The Art of Manliness Podcast. When it comes to investing, your brain can be your best friend or your worst enemy. My guest today explains how and what you can do to ensure your brain is a staunch ally in your quest for financial security. His name is Daniel Crosby. He’s a psychologist, behavioral finance expert, and the author of the book The Behavioral Investor.

We begin our conversation discussing the surprising ways sociology and physiology influence our financial decisions. We then delve into the psychological factors that cause us to make bad investment choices, including ego, conservatism, attention, and emotion. Daniel then walks through ways you can mitigate those factors in your financial choices, and we end our discussion outlining what an investing framework looks like based on the principles of behavioral science. Other principles discussed on the show relate to making sound choices in the area of financial investing that actually are pretty relevant to making good decisions of every kind. After the show’s over, check out our show notes at

Daniel joins me now via Daniel Crosby, welcome back to the show.

Daniel Crosby: Great to be back.

Brett McKay: We had you on a couple of years ago talking about your book The Laws of Wealth. You got a new book out, The Behavioral Investor. It looks really cool. It’s got this awesome ink blot bull, which looks pretty badass. How is this book a continuation of The Laws of Wealth?

Daniel Crosby: This is the graduate level version of I think The Laws of Wealth. The Laws of Wealth was my 10 rules for getting your finances right, and it was sort of a paint by number. This book is admittedly a little more complex. I write in the first introduction there that my aim with this book was to be the most comprehensive look at the psychology of financial decision-making that had ever been written, and so that was sort of my audacious goal from the outset. That’s what I tried to do here is look at money and decision-making from every possible angle.

Brett McKay: Well, so you specialize in behavioral investing. That’s what this book’s about. For those who aren’t familiar with that, what is behavioral investing? When did it become a thing? What are the fields it brings together to do what it does?

Daniel Crosby: You’re right. It is an absolute mutt of a field, of a discipline. It sort of sits at the intersection of finance and behavioral science and sociology and psychology and decision theory and game theory. One of the things that I love about behavioral finance, which is sort of the name for my field, the proper name for my field, is that it does incorporate all of these things. It’s immensely challenging because there are so many fields and subdisciplines involved, so you never feel like you quite get your hands around all of it, but, to me, it’s a really gratifying challenge.

It’s risen to prominence in recent years because in the late 20th and early 21st century, there have been a number of Nobel Prizes given out in behavioral finance and behavioral economics. People like Daniel Kahneman and Richard Thaler and Robert Shiller have all won Nobel Prizes for their work. But the ideas that undergird a lot of what I’m writing about today go back to even biblical times. There’s references in Ecclesiastes to humility and diversification. It says in Ecclesiastes 11:2, “Invest in seven ventures. You do not know what disasters may come upon the land.”

I’m writing about some of these things through a scientific lens, but Shakespeare wrote about these things. They’re written about in the Bible. Adam Smith wrote about animal spirits in The Theory of Moral Sentiments in the 1700s. Keynes wrote about booms and busts in the early 1900s. These ideas have been around for a very long time, but we’re just now, through the lens of science and the scientific rigor, starting to call them by their proper names and codify them and classify them the way that a scientist would.

Brett McKay: Well, one thing I noticed that behavioral investing does, and you spend the first part of your book discussing this, is looking at the ways our bodies, our brains, our psychology, our relationships, all these things, how they cause us to make bad or good investment decisions. Let’s talk about sociology. That’s something you wouldn’t think of going to first because people think, “Oh, it’s a decision, it’s personal. It’s just me. Psychology is where to start.” But you talk about how sociology is a big influence on us as an investor.

Daniel Crosby: Yeah. I think the person that’s written about this most beautifully is Yuval Noah Harari, who wrote Sapiens and a couple of other wonderful books. In there, Harari makes the point that the thing that differentiates us from the rest of the animal kingdom is not communication, because dolphins and chimps do that. It’s not opposable thumbs. It’s not tools, because crows use tools. The thing that differentiates us from the rest of the animal kingdom is we are able to believe in what he calls functional fictions. These are things that are not strictly, rationally true, but that serve a species-wide purpose. To make that a little more concrete, he says that money and economies are sort of foremost among these things.

Everyone that’s listening to this show spends most of their day toiling away for these pieces of little green paper or numbers in their bank account that have no intrinsic worth aside from the worth that we have ascribed them as a society. He says this is where we differ from the rest of the animal kingdom is that we can create states and constitutions and economies and things that aren’t literally true, that don’t have a basis in objective fact but still have collective utility and collective truth by virtue of our group agreement upon these rules.

We learn that in a very real sense, from the time we’re born, we believe in stuff that’s not true because it’s expedient. That’s done great things for us as a species, but it means that we tend to reason not in rational terms but in group terms, and when you apply that sort of herding behavior, that crowd mentality to something like trying to choose a good stock or trying to time the market or decide how to invest, that same tendency that serves us very well when we’re setting up a nation or a church serves us very poorly as investors.

My favorite bit of research on this in the book talks about this Asch experiment, which is an experiment that was done 50 years ago plus, where they had people look at three different lengths of lines. They had a group of lines on the left and a group of lines on the right and say, effectively, “Which line on, which …” Excuse me, one line on the left and then a group of lines on the right and say, “Which line on the right looks the most like the line on the left?” Well, what they would do is they would put people in groups so that confederates of the experiment, six or seven people, would go before and give the wrong answer, and so by the time they get to the last person, 76% of the time, the last person who was not in on the joke, not in on the experiment, would also give the wrong answer.

Now we used to think that this was just a simple matter of peer pressure, but brain science now, we’re able to observe what happens in an experiment like this. When we monitor brain activity with an FMRI, we find that this person’s, the parts of their brain that are lighting up during this experiment are those that are associated with sensation and perception. So, the groups thinking that the wrong line was the match actually changes the way that last person physically sees it. They’re not just getting pressured into doing something different. They’re actually seeing it differently than it is because the other people in the group disagree. We have to understand this as investors that other people’s opinions of a market, of a stock actually can warp our perceptions in real ways.

Brett McKay: No, that’s powerful. I’ve experienced that. If you grew up in the ’80s and ’90s, you probably experienced this with baseball cards. That’s a perfect example. I was convinced when I was 12 that I would pay for college and my retirement with my baseball card collection. Now, it’s in my attic and it’s worth nothing.

Daniel Crosby: Yeah. The baseball card bubble has been well-documented. There was also a really profound bubble, I think, a few years later in Beanie Babies. There was a book written on the Beanie Baby bubble that is an absolute thrilling must-read, and the guy that was in charge of, the guy that invented Beanie Babies, was this salacious character and just doing all kinds of shady stuff. But we had the Beckett Monthly, right?

Brett McKay: Oh, yeah.

Daniel Crosby: You remember Beckett.

Brett McKay: Yeah.

Daniel Crosby: You would get your monthly thing and you would check. It’s the equivalent of a Bloomberg terminal for little kids in the ’80s where we would sit there, and every month it only went up. Your Frank Thomas card or your Ken Griffey rookie card or your Jose Canseco card only ever went up. And you had these positive feedback loops with the Beckett magazines. Then we had a glut of supply. It used to be just Topps, but then you had Fleer and Donruss and Upper Deck and all these late entrants when it started to take off.

Yeah, the things that were present there, you had this collectivist mentality. Every person our age thought that they were going to go to college based on their Ken Griffey rookie card. But we’re comparing that to a time when the Honus Wagner card came in tobacco packs and they had to shut them down because people got upset that they were selling cigarettes to kids basically with these cards inside. They’re extremely rare and you contrast that with a time when you’ve got a new baseball card startup popping up every other year. These feedback loops like I just talked about precipitated this bubble, and you see that that collectivist mentality was a lot of what propped it up until we no longer agreed that they were worth what we thought they were worth.

Brett McKay: You’re seeing something similar with cryptocurrency, right? Two years ago, there’s this huge spike in Bitcoin, but now there’s all these other cryptocurrencies. The market’s still trying to, the group’s still trying to decide what’s this thing worth? And no one really knows yet.

Daniel Crosby: Well, cryptocurrency is a great example. Everyone loves to dump on cryptocurrency, but the thing is, our fiat currency, our money, is really no different than cryptocurrency, except perhaps at this point in that it’s backed up by big guns and big governments, but cryptocurrency is a perfect example of this. It was two, whatever, Thanksgiving last, it was worth $20,000 a coin because that’s what people thought it was worth. Today, it’s worth whatever, 3 or 4,000, because some of that trust has been eroded and people no longer have the sort of collectivist consensus around this. We need to understand that you don’t find stock prices, you don’t dig up stock prices from the earth and they don’t have an objective reality. They’re worth what we all think they’re worth, and understanding that human tendency is a powerful first step towards being a good investor.

Brett McKay: Another part of ourself that you wouldn’t think would influence investment decisions or financial decisions is our physiology. Our body can actually influence our decisions. Talk about that a little bit.

Daniel Crosby: Yeah. I think this one is perhaps the most ignored. It’s a little bit, candidly, discomfiting to learn about how central your body is to the way that you think about the world, because each of us has the subjective sense of being in control. Being in control, we’re making good decisions based on the available information and these decisions are more or less objective. But in my research, I found a lot that sort of speaks against this strongest form of free will and talks a lot about how our bodies have a huge impact.

Couple of examples are there’s been research on the power of music. When liquor stores play French music, the consumption of champagne goes up 75%. When they play German music, consumption of German beer goes up 50%. When they play music, classical music on the Tube, violent crime drops dramatically. There’s all these things that what’s going on in your body and your surroundings has a ton to do with the way that you make decisions.

I cite a famous study in the book that talked about Israeli judges, and it found that the best predictor of the harshness or the leniency of an Israeli judge’s ruling was how recently they had eaten. So, the further they were away from a snack or a mealtime, the more punitive they became. We’re talking about the best-educated, the upper crust, the intelligentsia of one of the most technologically advanced, great civilizations the world has ever known, and the smartest 2% of Israelis are making decisions after eight years of college based on how recently they’ve eaten lunch. But I promise you that if you ask someone who’s coming out of a liquor store, “Why did you buy that beer?” or you ask an Israeli judge, “Why did you throw the book at this prisoner?” neither one of them is going to say, “Because of these subtle bodily cues.” Yet, that’s what the research tells us.

It’s a little unnerving to learn how sort of fickle we are and how fallible and how quickly we can get moved away from this sort of homeostatic set point where we make the best decisions.

Brett McKay: You could be hungry and decide to sell all your stock and go all in on something else just because you’re hungry.

Daniel Crosby: Yeah.

Brett McKay: It’s a possibility.

Daniel Crosby: That’s absolutely plausible. Substitute hunger for myriad other emotions, upset with your spouse, didn’t sleep well the night before. Two nights of missed sleep is the equivalent of a hit of acid. All of these things impact our decision-making in really, really powerful ways. Let’s say you got a young kid in the house. I have a young son who wakes me up just about every night and he’s really messing with my investment decision-making. All these sort of very quotidian, everyday factors like how recently you’ve eaten, how your kids are sleeping, all of this could wreak havoc on the way you manage money.

Brett McKay: Well, and this is The Art of Manliness. Testosterone, I think they’ve done studies on that, testosterone has a big influence on how stockbrokers make investment decisions. If they have higher levels of testosterone, they take more risks. That’s what testosterone does.

Daniel Crosby: Yeah. There’s a great book by John Coates, it’s called The Hour Between Dog and Wolf, that’s all around his studies of testosterone on traders on the floor of stock exchanges back when we did that, had open, or outcry markets. Well, what they found was that testosterone increased in winning traders. You’re on a hot streak, you’re trading your face off, you’re doing great, you’re compounding your money, you’re doing great, testosterone increases and increases and increases until we take dumber and dumber risks.

For a while, it’s helpful, this increased level of testosterone is actually helpful. It makes your senses more acute. It makes you sharper and more confident. But then at some point, it spills over into overconfidence, and he talked about observing this in the animal kingdom as well, rams and different animals who would fight for a mate. They would win a couple of matches in a row, they’d win a couple of these head-to-heads in a row, and then they’d start taking stupid risks.

Yeah, it’s a real consideration. At the risk of being booed off The Art of Manliness stage here, women on average are much better investors than men. Part of it’s the way that they’re socialized, but part of it’s genetic. Part of it’s biological, physiological.

Brett McKay: Maybe that’s why older men do better, too, like a Warren Buffett type. He’s probably about … Doesn’t have the testosterone levels of a 25-year-old Warren Buffett.

Daniel Crosby: Well, the worst traders are young unmarried men. The best traders are married, older married women. And then older married men are just behind them. I think that has a lot to do with it.

Brett McKay: Right. So, sociology can jack us up. The people that we associate with, the group, can mess us up. Our physiology can influence our decisions, sometimes good, like the testosterone can be good, but at a certain point, it’s diminishing returns and actually negative returns. Let’s talk about the psychology. You talk about there’s four factors in our psychology that can cause us to make bad investing decisions. There’s ego and there’s conservatism, attention, and emotion. Let’s start with ego. First off, what do you mean by ego, because people have different ways of describing that? And then how does our ego cause us to make bad investment decisions?

Daniel Crosby: Yeah. Ego in this case is not like ego in the Freudian sense. This would be ego in the sense of overconfidence. Overconfidence, again, our research suggests men are more prone to overconfidence than women, especially with respect to money. But overconfidence takes a couple of forms, three to be exact. Overconfidence, we tend to think we’re luckier than other people. We tend to think we’re smarter than other people. And we tend to think that we can forecast the future better than we actually can.

If you think about each of these, the luckier thing, people tend to say … If you ask someone, “What are the odds of you getting divorced?” they’ll say, “Ah, never happen.” “What are the odds of you winning the lottery?” They go, “Well, maybe.” We see this across contexts that when we ask people about bad things, they dramatically underestimate the risk of bad things happening to them and dramatically overstate the probability of really positive things happening to them. This systematic, sort of misapprehension of the world leads us to take outsize risk, leads us to do all sorts of dumb things because we think it can’t happen to us.

The second piece there is just thinking we’re better than other people, we’re smarter than other people. There’s great research that the last paragraph of this research said that the average man thinks that he’s two sit-ups away from dating a super model, because they found that 90+% of men think they’re friendlier than average, smarter than average, and more athletic than average. We all think we’re better than we really are.

The thing about this, and a theme throughout the book, is that this serves us very well in many respects, this overconfidence. It helps us bounce back from tough times. It helps us bounce back from rejection. It gets us out of bed in the morning. It leads us to approach the girl at the bar that we probably have no business talking to and we end up marrying. There’s a lot of good stuff that comes from overconfidence and then sort of a rosy look at the world. But you can’t bring it to the world of investing. That’s just a theme we see again and again in the book is, look, this stuff evolutionarily exists for a reason, but Wall Street is a different animal and you have to leave this overconfidence to the side.

Brett McKay: How does that manifest itself, that you’ve seen, where there’s overconfidence amongst investors?

Daniel Crosby: Well, one is day trading, people just making, thinking they can go it alone, thinking they can go it without any real education or any assistance from a professional, overtrading accounts. I see a lot of people holding too-large positions in a single stock. All of this is ego because they think, “Well, I know something. I have insider information. It’s not going to happen to me.” I talked to a gentleman at a conference who had $2 million. He came up to me and was like, “Look, I have $2 million. Half of it’s in a diversified portfolio. Half of it’s in this single stock. What do you think about the prospects for this single stock?” I was actually incredibly bullish on the stock at the time, and it’s done very well since, but I told him, I’m like, “You have to sell this. You have to diversify away from this position,” because you can be right and still be a moron.

Good investing, good behavioral investing is about playing the probabilities. It’s like playing cards. You tilt probability in your favor at every turn and you never make an outsize bet that can ruin you. I have no idea what he did with that million-dollar holding in a single stock, but even though it’s gone up since then, I hope he sold it because that was the right thing to do. That’s how you win as a long-term investor, by tilting the odds in your favor, not by getting lucky.

Brett McKay: Well, I thought another key takeaway for me on this section about ego is that, particularly in regards to the stock market, is that we actually become more egocentric. By egocentric I mean we have overconfidence when there’s more complexity in our environment. The stock market, it’s one of the most complex things out there because it’s just, it’s all based on groups of people trying to decide the value of this fictitious thing out there.

Daniel Crosby: Yeah. You make a great point. There’s so many paradoxes about human nature as they butt up against the stock market, but one of them is that the more complex and dynamic a system is, the more simple your solution needs to be. This is profoundly counterintuitive. We think that the more complicated a system is, the more dynamic it is, we need complex dynamic rules to beat it, and the opposite is true. I talk about this in the book.

Yes, the stock market is enormously complicated. It has effectively an infinite amount of inputs, and because that is the case, you will never, ever figure out the rules. There will never be a perfect formula. Accordingly, the people that tend to do well in the market tend to follow a handful of simple rules. They don’t try and time it. They automate their decisions, and they kind of let it run. And it’s not a sexy thing. It kind of flies in the face of where we want to be, but because the market is so complicated, for that very reason, your solution necessarily needs to be simple.

Brett McKay: I imagine the folks who come up with complex solutions, because the solution is so complex and they feel like they thought this through a lot, they’re going to be more certain of their solution, even though it’s probably the wrong solution.

Daniel Crosby: Well, there’s great research on that. They talk about betting, betting in college sports and how folks do if they’re given … I’m from Alabama, so let’s say Auburn and Alabama are going to play, and I give you four variables. I give you the average weight of the offensive line and a couple other variables. Then they ask people to bet on the outcome of the game. They do this with four variables, eight variables, 10 variables, 25 variables. People’s ability to predict the outcome of a game is flat across all those variables, but their confidence increases with the complexity, increases with the number of variables. People with four pieces of information are no better at guessing who’s going to win that football game than people with 25 pieces of information. But they’re much more confident in their ability to predict it, and accordingly, take more leveraged bets, take bigger bets, take stupider bets.

The same thing is true in the stock market. You see some of the brightest people around have figured out complicated systems to try and master the market, but what has invariably happened to them is that they’ve blown up. They’ve blown up. They’ll do well for a time, and then they blow up. Look up Long-Term Capital Management or any number of others. The complexity becomes the undoing in the long term and the complexity is also, just as you said, the very thing that leads them to take stupid bets in the first place.

Another thing that I like to tell people to do to try and mitigate this overconfidence is to define the problem as precisely as possible, because when the question is vague, when you ask people, “Are you smarter than average?” almost everyone says yes because smart is kind of this vague thing. Some people think it looks like street smart. Some people think it looks like having an advanced degree. There’s not much agreement on what smart is, and so most people go, “Yeah, I’m smarter than average.”

But if I ask you, “Are you a better oil painter than most people?” you go, “Oh, well, no. I’m definitely not a better oil painter than most people.” The more precisely you can define a problem, the more likely you are able to be, to sort of match your own skills up against your ability to complete that problem.

Brett McKay: Well, besides that, is there anything else that you can do to mitigate the downsides of ego when you’re investing?

Daniel Crosby: In investing, the easiest way to manage ego is to just diversify, to diversify across a number of different asset classes. Then within each of those asset classes to make sure you’re holdings are diversified within and across asset classes, because diversification, we’ve all heard about it as don’t keep your eggs in one basket, and that’s right. That is what it is. But psychologically, you’re basically saying, “I don’t know what’s going to happen.” Diversification is effectively saying, shrugging your shoulders, saying, “I have no idea what’s going to happen. I have no idea of stocks or bonds or real estate or gold or whatever other thing is going to be the next big winner, so I’m just going to own them all.” That is one of the most humble things you can do, and its not sexy, but it works.

Then the last thing I would say is to become a teacher. I follow Richard Feynman’s admonition here, the great physicist, and he used to ask people this sort of cheeky question. He would ask people, “Do you know how a toilet works?” Everyone’s like, “Yeah, I know how a toilet works. I use a toilet a couple of times a day, so yeah.” And then you go, “Okay, well, great. Teach me how a toilet works.” And then people would stutter and stammer and realize they had no idea how a toilet works.

For me, the process of writing books is one of the ways that I keep myself in check, because when I try to tackle these big problems and write these comprehensive books, I end up finding the holes in my logic, the gaps in my understanding. And so becoming an educator on these things, trying to teach a friend or a spouse about finance is one way that you’re going to realize you don’t know as much as you perhaps thought you did.

Brett McKay: Well, if it’s really hard to explain your investment strategy to your 13-year-old daughter or son-

Daniel Crosby: Yeah, exactly.

Brett McKay: … that might mean you need to do something different.

Daniel Crosby: Exactly.

Brett McKay: The other psychological factors that get in the way of us making good decision is conservatism. Talk about that a bit.

Daniel Crosby: Conservatism is the tendency for us to confuse what we’re familiar with with what is safe or desirable. You see this in a couple of ways. The first way is that people tend to dramatically overinvest in their company stock. A second way that we see this is by geography. People in the northeastern U.S. seem to be overweight financial sectors. And people in the Midwest tend to be overweight agriculture stocks, say. We also see this on a national level.

I spent three months in Canada last summer. I lived in western Canada last summer, and it was absolutely gorgeous. Can’t wait to go back. But Canada was interesting because they’re … About 4% of global GDP comes from Canada, and yet, the average Canadian had about 65% of their wealth in Canadian stocks. The reason they did this is because they knew them, and they thought by virtue of them knowing about these companies that they were safer or better. But a good rule of thumb is to own stock in relative proportion to its share of the equity pie worldwide. The U.S. is just over half. As a good rule of thumb, about half of your stocks should be in the U.S. and the other half should be international.

Yeah. We see this all over the place, though, where it’s like, “Because I know it, because I’m familiar with it, therefore, I’ll invest in it,” and it’s actually quite dangerous. We saw during the Greek debt crisis. Greek is some teeny, tiny percentage of the world economy, and yet, Greek investors had a majority of their wealth in Greek stocks, and it ended very poorly for them. So, something we have to be aware of.

Brett McKay: And I imagine, too, this can get in the way, it’s that loss aversion. As soon as we own something, it’s ours and we don’t want to lose it, even though it would make sense just to get rid of it. You buy a stock and it’s doing terrible, you don’t want to dump it because that’s the devil you know.

Daniel Crosby: Yup, absolutely. There is a real devil you know factor. You’re talking about loss aversion and also endowment effect, which is this idea that by virtue of owning something, it becomes more valuable. This is why people have trouble selling their houses or selling their junk at a garage sale, because we think just because it’s ours, it’s worth more than the market will bear. That’s a very, very common tendency. The reason this is so dangerous is because it basically, you’re stocking risk.

I live here in Atlanta, and so let’s say I live in Atlanta and I work for Coca-Cola and I invest in Coke stock heavily through my personal investing. Then I invest in Aflac and UPS and other, Cox Communications and other local companies because I know them and I have friends there, so they feel like known entities to me. Well, if the Atlanta economy hurts, if something happens to Coke and people stop drinking as many soft drinks, my house value goes down, my stocks go down. I may lose my job, and my local economy’s impacted. You’re like quadruple loaded when you do this, when you fall prey to this conservatism bias.

Brett McKay: And we could become more conservative based on our environment. I think they’ve done … You highlighted studies when the stock market is going down, people stop investing in the market. They might even sell and they just go put everything into cash or bonds or gold or whatever, and it’s just because the group decided, well, the stock is not as worth as much as we thought it was.

Daniel Crosby: Yeah. It’s fascinating, because one of my big projects at work right now is developing this tech simulation of the stock market, basically a stock market game that monitors people’s behavior and tries to make inferences about how to keep them from making bad decisions. What you see again and again is people do the exact opposite of what they should do. When the stock market has run up for years at a time, they go, “Okay, now let’s take some risk.” Well, at that very moment, it’s riskier than it’s ever been. Then when the market crashes, they go, “Oh, okay. Let’s take some risk off the table.”

Howard Marks, this billionaire famed investor, calls this the perversity of risk, which is that risk is most felt when it is least present, and it’s least felt when it’s most present. It’s a tricky paradox again, but just about the moment you’re starting to feel safe, you should start to worry, and just when you’re at your period of maximum worry, you should start to take some risk.

Brett McKay: But the thing is, though, that’s hard to figure out. You don’t know. It’s like, okay, is it going to … This rally we’re having, we had that big bull market going on for … It started going down in July. You’re like, “Oh, should I sell now? Is this the point?”

Daniel Crosby: Yeah, it absolutely is. The thing is it will never really feel safe. When you look back over a hundred years of the S&P or the Dow, there’s always been a reason not to invest. You look at Warren Buffett’s lifetime where he’s compounded his wealth so extravagantly, there have been numerous world wars. There have been flu outbreaks. There have been pandemics. There’s just been political scandals. There’s always going to be a reason to worry, and we always think that our time is sort of uniquely bad. 

This is cutting to the chase. This is where I think that one of the biggest tools in a behavioral investor’s arsenal is automation, just being able to take the decision-making process off the table, having some solid rules about investing consistently, escalating those investments as your income grows, and frankly, just worrying about more important stuff, because life is much more than the things we’re talking about today. The sooner you can automate these things, the happier you’re going to be and the richer you’re going to be.

Brett McKay: All right. To counteract conservatism, just put your investment on autopilot.

Daniel Crosby: Yeah, yeah. Put it on autopilot. Another thing you can do is to take away the fear of loss. I talk in the book about Hyundai, the car maker program during the great recession. Automakers were getting destroyed and Hyundai says, “What can we do to sell some cars in this awful environment?” They started a program that said, “Buy a Hyundai, and if you lose your job, we’ll buy it back at full price. We’re going to buy it back at full price.” They had an 8% increase that year in a horrible market. Everyone else was getting killed, and they were up 8% that year in terms of their sales because you took the worst case scenario off the table.

This is something that me and my wife do. Once we passed sort of our first significant milestone, our first significant financial milestone, we said, “Look, we don’t want to go back from this place.” So, we have a bucket of money in a safety bucket, and it’s candidly not getting market returns. It’s getting 2.50, 3% and has been for a couple of years. But it helps us sleep well at night, and it takes away the fear of loss so that we can be more aggressive with some of our other assets. That’s another big one.

Then finally, procrastinating. We’re much less likely to rely on the status quo or to do what’s always been done if we sleep on it. We’re about 30% less likely to just take the default option if we just take a day, think it over. Never get pressured by a financial salesperson. Never make a big decision about your money in a hurry. Always take that day, that 24, 36 hours to sleep on it, think on it, and you’re going to be much less likely to fall prey to this.

Brett McKay: Yeah, the bucket strategy sounds like Nassim Taleb’s barbell strategy.

Daniel Crosby: Yeah.

Brett McKay: Where we have one, you have one, 10% in just CDs, bonds, safest thing you could possibly have. Well, no, most of it’s in CDs and bonds. Then you use 10% to take … He’s a hedge fund guy, so he’s taking bigtime risk. The downside, admittedly it’s the downside. But the upside is really great if it works out.

Daniel Crosby: Yeah. Yeah, there’s really something to it. I use sort of three buckets. I have a safety bucket, a market bucket, and then a sort of shoot-the-lights-out, drive-a-Bentley-one-day bucket. These are sort of my three. But that safety bucket is such peace of mind. Again, mathematically it’s not optimal. I’m getting suboptimal returns on that, but one of the things you learn when you study behavioral investing is the best portfolio is the one that you can stick with.

Brett McKay: Let’s talk about attention. The stuff we pay attention to in the world can influence our decisions. How so?

Daniel Crosby: Yeah. Attention is all about this human tendency to confuse what’s scary and weird and vivid and newsworthy with what is likely. The silliest example that I cite in the book was that many, many times more people died last year of taking selfies than died in shark attacks, and yet, we’re very scared of sharks and we’re not all that scared of taking selfies. It’s because we just don’t think about the world in probabilistic terms. The things that we hear about on the nightly news are what scares us. Odds are that you and I are going to die of cancer or a heart attack or something, and yet, here we are worried about terrorism and crashing in a Boeing 737 and all kinds of things that are statistically unlikely. Yet, I’m going to go eat a hamburger tonight and bring myself closer to something that’s very likely like a heart attack.

Part of becoming a behavioral investor is learning to think in terms of base rates, to think in terms and assess probability on the terms on which it actually happens and not just on the terms on which you can recall it.

Brett McKay: That sounds like the way that attention can infect our investing is you just remember the bad things that happen. If you’re a millennial, you just remember the great recession. You’re like, “Well, that sucked. I’m not going to invest in stock anymore.” If you’re a greatest generation, you remember the Great Depression, say, “Well, I’m going to put all my money under the mattress.” But you ignore all the other times where things were great in the stock market.

Daniel Crosby: Yeah. That is an absolutely fantastic example. You look at someone like me. I got out of grad school in 2008. I get my first big boy job in 2008, and I start saving and immediately it’s just crushed. Immediately, whatever meager sum I had put aside was halved because of the great recession. There’s something in psychology called a primacy and a recency effect where we have a better memory for events that happened to us early in a sequence and late in a sequence. We tend to be overly influenced by things that happened early in our investing lives and things that have happened recently.

You think about Q4 last year, we had such a choppy market in November and December. Someone my age in Q4 last year is going, “Well, look, I got into the market. I got crushed. Here we are again. It’s getting crushed. All this stupid market does is go down,” ignoring the fact that it’s up 400% in that intermediate period. That’s attention at work, is these big high profile events sticking in our minds and looming larger than life than the actual numbers and the actual reality.

Brett McKay: How do you overcome that?

Daniel Crosby: There’s this idea of base rates, which is just planning around probabilities. If you look at some of the probabilities in the market, the market in the last 35 years has dropped 14% a year on average. On average, there has been a drawdown some time in the year from a peak to a trough of 14%, and yet, every time we have an 8 or 9% drop in the market, CNBC has a Markets in Turmoil special, we’re freaking out like we’ve never seen this before, and it happens as regularly as Christmas and your birthday. It happens all the time. It’s because people have forgotten about base rate.

I think one of the things to do is become a bit of a market historian, to know what average looks like, because I think about this with marriage, too. If you ask someone on their wedding day, and you really shouldn’t do this, but if you ask someone on their wedding day, “What’s the likelihood of you getting divorced?” if they’re honest with you, they should say, “Well, 50-50.” Yet, we don’t think in those terms, and because we don’t think in those terms, we don’t prepare adequately and we don’t maybe treat marriage with the care and the care that it deserves. The same is true of markets. If we knew the odds better, we’d better know how to react. Becoming a market historian and attending to those base rates is extremely important.

Brett McKay: Maybe you tape up a chart of the base rates next to your computer so if you make a decision, you look at that first.

Daniel Crosby: Yeah. Well, I think there’s just a couple of things to know. The market tends to be up. The market tends to be up about two days for every one day that it’s down. If you have a down day or even a down year, it’s not that rare. It happens about a third of the time. That’s no excuse for you to get off course. The average bear market’s about a year and a half to two years long, and it has about a 37% loss, destruction of capital. But I promise you that the next time that the market drops 30%, people are going to think that it’s going to zero. We don’t understand the base rates. We don’t understand the history. We don’t understand what normal is, and because we don’t understand what normal is, everything seems scary to us. I love your idea, just having a note card with a couple of those basics and keeping it right there.

Brett McKay: Well, you just mentioned something that I thought would be useful, because don’t check your portfolio every day because you’re going to see it’s going to go up and it’s going to go down, it’s going to go down more, it’s going to go up. Maybe once a month, maybe once a quarter.

Daniel Crosby: Yeah. What’s interesting is the longer you can go between checking it, the more likely you are to be up, because if you look at any given day, the market’s up about 60% of the time and down 40% of the time. You look at any given year, it’s about 66, 33. You look at any 10-year period, I think there has only been one rolling 10-year period in U.S. history where the market was down. The longer you can go between looking, the better off you’ll be. One of the things that is actually very much to the detriment of everyday investors is the ease with which we can check our accounts now. Back even 20 years ago, you had to wait on a quarterly statement, and now you can check your account 15 times a day, and I know many people do.

The tricky thing is one of the findings of behavioral finance, this is what Daniel Kahneman won his Nobel Prize for, is that a loss hurts two and a half times as much as a gain feels good. If the market’s down 40% of the time daily and it hurts two and a half times as much as the 60% feels good, it feels like it’s down 90% of the time. In a very real sense, if you’re checking it daily, it’s going to feel like you’re always losing money, even though that’s not the case.

Brett McKay: All right, so don’t check your portfolio every day or 15 times a day. Emotion, we talked about emotions a little bit at the beginning, being angry, being hungry, being hangry, thirsty, happy, sad. That could all influence our decisions. The weird thing with emotions, though, there’s been studies that showed, you talk about this in the book, we actually need emotions to make decisions. How can you make decisions while mitigating the downsides of emotions? Because you need them, right?

Daniel Crosby: Yeah. Some interesting research I cite in the book that you brought up talks about how people who had the emotional processing centers of their brain damaged, they couldn’t decide which flavor of ice cream they wanted, they couldn’t figure out which color suit they wanted to wear that day. They couldn’t make even very sort of garden variety decisions, because what the researchers found is that even the simplest decision has an emotional substrate. Even the most common decision you make has an emotional underpinning to it that’s important and guides our decisions.

There’s no getting away from emotion entirely, but what’s fascinating is they found that these people who couldn’t pick out their favorite flavor of ice cream were actually great gamblers and great investors because they approached investing and gambling from a strictly mathematical place. There was no emotion involved in their day-to-day decisions, but there was likewise none involved in their investing decisions. They beat people with normal brain function, so people with brain damage were better than you or I at making financial decisions.

The key to me is avoiding emotional extremes. There’s an acronym that I’ve stolen from the 12-Step Program called HALT that stands for hungry, angry, lonely, or tired. The advice of people in AA or Narcotics Anonymous or any of those 12-step groups is to avoid making an important life decision when you are hungry, angry, lonely, or tired. Fill in your emotion of choice. I would say the same thing about investments. If you’re fearful, if you’re greedy, if you’re excited, all of these are bad places to be. Good investing is enormously boring, and so if you find yourself in one of these elevated mood states, it’s not a good place to be in terms of doing anything with your money.

Brett McKay: We talked about all the sociological, the physiological, the psychological things get in the way of us making good decisions, and we talked about some solutions, and the solutions, they’re very simple. This framework you established, it’s basic and it’s stuff that we know, but now it’s backed by science. Diversify, automate, don’t check on it too frequently, and don’t make decisions when you’re emotional.

Daniel Crosby: Yeah. That’s what’s fascinating about this is you write a 300-page book, you read a zillion articles, and then at the end, you go, “Okay, here’s what you do. You automate.” The simple rules beat human discretion 94% of the time. You get an advisor because there’s about 10% of the world, I think, that is so disciplined that they can do these things on their own. Those people do exist, but most people need someone to hold their hand and keep them from making a handful of dumb decisions. You manage your fees, you try not to be overactive, and you have low turnover, you diversify. In some ways, the suggestions are remarkably unsexy, but, again, the degree to which all of this is complicated in a weird way necessitates a simple approach.

Brett McKay: Well, you mentioned advisors. You and I actually had a phone conversation a couple of weeks ago about this, and I asked you who’s the type of person who should get an advisor? And you said it’s someone who probably needs help with the behavioral aspect. It’s not so much what to invest in, having someone tell them what to actually invest in. They might do that. But it’s more like you need an advisor to make sure you stick to the plan and you do the thing you’re supposed to do.

Daniel Crosby: Yeah. In The Laws of Wealth, chapter two of The Laws of Wealth is titled You Need a Financial Advisor But Not for the Reason That You Think. In that chapter, I make the case that the best, the highest and best use of a financial advisor is to effectively save you from yourself. And the research shows that people who work with an advisor on average do 2 to 3% better per year than those who do not, and that is a ton of money. So, 3% a year will double your wealth over a long investment horizon.

It’s tricky, though, because candidly, some automated service like Betterment or another robo advisor would give you, in many cases, the very same suggestions as a financial advisor at a fraction of the cost, but the question you have to be really brutally honest with yourself about is, is an automated service, is reading a book on asset allocations going to keep me in my seat when the market is ripping my face off? For most people, candidly, the answer is no. There’s a really, really weak correlation between knowing the right thing to do and actually doing it.

I love to give the example of nutrition labels on food. We started labeling all of our food about 28 years ago, and since that time, since this time when we’ve had perfect knowledge of calories and fat and sodium and sugar and every other thing on everything we put in our bodies, obesity’s doubled, morbid obesity is tripled, because knowledge is just a weak predictor of behavior. Even if you know just how to invest, even if you have a sound asset allocation, your ability to stick with that allocation is far more predictive of whether or not you reach your goals than you knowing what a good allocation is.

Brett McKay: That reminds me, I don’t know if this is going off in the deep end, but I’ve been re-reading Oedipus Rex, the Greek tragedy, and I thought it was interesting. Oedipus, he knew that he was going to kill his father and marry his mother. He knew that. That’s why he left his hometown. But he still did it anyways, because he just got angry and he killed the guy, an older guy. He shouldn’t have killed anybody, but he did. That’s a great example. This stuff’s been around for long. You can know this stuff, but you still screw it up.

Daniel Crosby: Yeah. I saw something the other day on marital infidelity. It’s something like 40% of people cheat on their partners. If you asked those people, “Hey, was that consistent with your values? Was that the thing you wanted to do?” they would all tell you no, or nearly all of them. It’s just incredible how little education does. It’s actually quite depressing. When you start looking into financial literacy initiatives, as a guy who writes books that try and educate people on how to manage their money and what to do with their wealth, it’s depressing. Really, I think education is necessary, but not sufficient. The next thing you need to do is put in place structures, be they automated or be they an advisor, that are going to help keep you on the course. Education tells you which course to go on, but you need some sort of commitment device that keeps you on that course, and that’s going to be a much better predictor.

Brett McKay: You want to be like Odysseus and tie yourself to the mast.

Daniel Crosby: Tie yourself to the mast, fill your ears with beeswax just like Odysseus.

Brett McKay: There you go. I like how we got Greek here a little bit. Well, Daniel, where can people go to learn more about your work?

Daniel Crosby: A couple of places. I have my own podcast called Standard Deviations. I’m active on Twitter @danielcrosby and on LinkedIn a lot, Daniel Crosby PhD. And you can find the books on Amazon.

Brett McKay: Well, Daniel Crosby, thanks for this time. It’s been a pleasure.

Daniel Crosby: My pleasure.

Brett McKay: My guest today was Daniel Crosby. He’s the author of the book The Behavioral Investor. It’s available on Also check out our show notes at where you find links to resources, where you can delve deeper into this topic. 

Well, that wraps up another edition of the AoM podcast. Check out our website,, where you can find our podcast archives as well as thousands of articles written over the years on personal finance, physical fitness, how to be a better husband, better father. And if you’d like to hear ad-free episodes of The Art of Manliness, you can do so on Stitcher Premium. Get a free month of Stitcher Premium. Sign up at Use promo code Manliness. Once you sign up, just download the Stitcher app for iOS or Android and start enjoying the ad-free Art of Manliness experience. If you haven’t done so already, I’d appreciate it if you’d take one minute to give us a review on iTunes or Stitcher. It helps out a lot, and if you’ve done that already, thank you. Please consider sharing the show with a friend or family member who you think would get something out of it.

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