The Importance of Behavioral Finance | AWM Insights #160
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Episode Summary
Understanding, processing, and regulating emotional responses toward your investments is one of the most important skills to have in order to be a successful and diligent investor.
Markets give us various inputs that lead to an array of feelings, but it is critical to process and regulate your emotional responses at all times and keep your eye on the bigger picture, which is your financial structure.
Trends come and go over the years. True multigenerational wealth can be everlasting if structured and implemented properly.
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Episode Highlights:
0:00 Intro
0:25 How do human emotion and behavior tie into investing?
2:45 History of the public stock market
4:22 Why the behavioral element of finance is just as important as the technical side
5:19 Why a robust understanding of markets helps investors over the long run
7:38 Being disciplined across market cycles
9:30 Managing your feelings and being diligent while looking at the bigger picture
11:00 Text us!
+ Read the Transcript
Brandon Averill (00:03): All right, we're back for another one of these episodes of AWM Insights. We've gone down this rabbit hole of technical expertise for a while and we're sitting here talking about what we could hit on today that might be valuable for everybody listening, and we landed on something that I think is super intriguing and something that's a battle for some, some it's easy, but it's really the behavioral side of investing.
(00:28): I think anytime we have market volatility, we have big events happening. Last week we hit on some of the big economic events that are happening. It brings or bubbles to the surface, hey, we can talk about a lot of this stuff, we have a lot of experience and we're well studied in what happens, but at the end of the day, this is still a major behavioral type coaching situation.
(00:56): We thought it'd be fun to dig into some of the things that are out there and hopefully provide a little bit of context and hopefully a little bit of comfort that when you have those kinds of anxiety emotions bubble up because you do see something on the news that that is normal, just reassure you. And then give a little context again to how to deal with those emotions and how to have a lot of confidence in the fact that hiring an advisor, for instance, is a great way to help protect you against some of those emotions that are naturally going to come up.
(01:27): Justin, I'd love for you to just dig in a little bit here. You've got a lot of experience over the years talking with clients. Just what's your perspective on some of the behavioral side of investing and maybe some kind of key points for our listeners to take away.
Justin Dyer (01:45): To your point, I think it's arguably one of the most important areas to focus on, and as an industry we just don't. And I think there's good reason for that. It's complicated. We humans are interesting creatures and we all have different emotions and different reactions, so it's hard to put a one size fits all categorization or classification on this, but it is really, really, really important to an overall successful investing experience.
(02:17): I think the one place to really start with this is the technical side. You do want an element of understanding the basics. What is investing, what are you actually doing with your money? And then a second place to go there is look at the history. What is the marketplace? What is the stock market? We can use that term broadly speaking. What has that done over time? How has that changed? It's been around actually for quite a decent period of time. And on the one hand, and at the same time you could say somewhat of a relatively short period of time in the grand scheme of humanity, something around 100 plus years give or take, and it's evolved substantially over that period of time.
(03:02): There's still plenty of reason to think it's an incredible creative wealth and there's still very strong reason, if not even more so of an argument than even 20, 30, 40 years ago, certainly 100 years ago, that the behavioral side of it is just as important or more important than it was back then. The statistic, kind of what you were talking about before we hit record, you had the stock market crash leading up to the depression, what it was something like 1% of the entire US population participated in the stock market. And so there was this element of wealth, element of sophistication that you needed to be an investor.
(03:44): Fast-forward to now, and there's a lot that's happened between now, then and now, but fast-forward to today, almost anyone can be an investor. You have a phone, a smartphone, download a Robinhood app or an Acorns app, and guess what? You're an investor with a dollar potentially. And that's an amazing feat of innovation. It's phenomenal. But at the same point in time, it creates all sorts of interesting feedback loops for investors, for people that are reading the financial press, the markets themselves, you have interesting forces that are now introduced to the market.
(04:24): I guess to summarize my statement here is, now probably more than ever, the behavioral side is as important as it ever has been and really having an appreciation that, hey, emotions are part of money, emotions are part of investing as a result of that and understanding that you can't really completely remove those emotions from the equation. Accepting that should set you up, along with the technical understanding and partnership, should set you up for long-term success.
Brandon Averill (04:58): Yeah, and I think it's kind of an interesting thing too. When I think about the behavioral side, I always go back to the lottery and it always blows my mind. We as humans, it's almost like we're predisposed that we want this lottery moment, we want the get rich quick scheme. No matter how smart we are and how much data we know.
(05:21): I was talking to a guy over the weekend, incredibly smart guy, and he is like, "Oh, I got my get rich quick scheme for the week." And he's explaining something. I'm like, "Why are we," ... The inherent get rich quick scheme everybody knows is bs. Everybody knows it's incredibly unlikely that you're going to win the lottery. I think it dampens, it seems, a little bit when we go to invest our money, but when you think about it, what we're all trying to do is invest our money to grow it to achieve the priorities that we lay out.
(05:56): And that's, really, I think what you're hitting on is that's why coaching today, maybe working with an advisor, could potentially be so much more important because the access to do this yourself is out there and I think it's almost like an overconfidence it's built within us that, hey, if we can just flip this one thing, I can maybe strike it rich. But you start to lose the sense of probabilities. And I think, right, that is back to if we think about what it actually takes to be a really good investor, it takes a few different things. You have to understand math, you got to understand statistics and how the probabilities actually work, and you probably need to actually acknowledge those probabilities as well. You got to have-
Justin Dyer (06:41): Comically overlooked, yeah.
Brandon Averill (06:42): Yeah. You have to have a good understanding of, over the long term, how have economic cycles worked? How do companies profit and reward shareholders in general? You got to really have an understanding of the financial history, booms and busts and what go through that. And that just all leads back to, I think, what the key takeaway we're talking about today is you have to have a very reasonable, our argument would be a robust investment strategy, but more importantly you have to stick with it.
(07:15): I think oftentimes we'll get into conversations with prospects or people that want to become clients of AWM, and it's this nuance between, well, do you believe in an index strategy versus a smart index strategy? We have our beliefs and it's very much rooted in evidence, but at the end of the day, if you're flip flopping in and out of different things, it doesn't really matter. You got to buy into a philosophy and then you got to stick with that over multiple decades to really get the fruits of what you're putting your money into.
Justin Dyer (07:50): Yeah, and that's an excellent point because I hate to break it to everyone that every single philosophy or approach is going to have a period of time where it is underperforming. Relative to what, it's specific to that strategy benchmark, but it's going to happen. You need to be able to go back and say, "Oh, well, I was prepared for this." We know that this is within reason and kind of expected as much as you can create a plan or an expectation ahead of time and stick through that. If there's still the logical building blocks that support that strategy, you should very much do that. And this is really the behavioral period.
(08:32): Instead of having that inclination to say, "Oh, well, we're underperforming at this point in time, we're going to go do X, Y, Z and chase that investment." Not only are you potentially incurring costs ... Now one thing that has happened over the market, over the history of the market is transaction costs have come down substantially, which is again, both good and bad. It allows people to participate in much higher volume, but you need to think through the long term aspect of it. You can't just constantly transact and chase your tail, which I think you kind of hit on because that's just setting yourself up for failure and constantly looking for that next hit of dopamine or next lottery ticket, if you will, and playing that game, it's just really not investing. At the point in time is gambling.
Brandon Averill (09:28): And I think as a takeaway, or maybe to sum it all up, hopefully what you guys are taking away and our coaching over the years has helped you to realize is that when you get nervous, you see something on the news or you look inside your account for some reason over whatever period you're looking at, things don't look too hot, or you have a friend that tells you X, Y, and Z is the way to go. Or on the positive side, say, you look in your account and things are magnificently-
Justin Dyer (09:59): Good point.
Brandon Averill (09:59): ... performing well, it's on the both on the up and the down, is to acknowledge number one, that's normal. It's normal to have feelings around all this stuff. Two is to remind yourself that where are you actually seeing this and what's the source of the information? Is it a news cycle that's there to sell ads and raise up these emotions in your being.
Justin Dyer (10:19): To speak directly to your behavioral side?
Brandon Averill (10:21): Correct. Is it maybe a well well-intentioned friend or family member or teammate that is telling you about the wins but not the losses potentially? And really what's their expertise towards all of this? How well studied are they on the things that we went through, probability stats, history of the markets, investing in general? What are they really qualified to be giving you advice on?
(10:46): And then once you assess those things, take a deep breath and remind yourself that you have a really robust plan in place. We talk a lot about the protective reserve. We talk a lot about allocating appropriate resources to growth. And just remind yourself that the financial structure that you've done the work to put into place with us is allowing you to go through different market environments for success over the long term, success being defined on you reaching your priorities.
(11:14): I know it's a little bit of an esoteric episode here, but I think what we really want to get across is just, it's normal. It's normal to have feelings. Acknowledge those. Take a deep breath and just bring yourself back to the hard work that you've done to put a really solid financial structure into place.
(11:32): With that, we're going to end up today, but as always, shoot us a text 714-504-7689 if you have topics you want us to hit in the future.
(11:42): But for today, and until next time, own your wealth, make an impact, and always be a pro.