Investor misbehavior: It’s the scurvy of the financial services industry.
So suggested Daniel Crosby, the psychologist and behavioral finance expert who recently co-authored Personal Benchmark, during the Financial Services Institute’s second annual Financial Advisor Summit on Wednesday.
It took over 500 years for the official cure for scurvy, Vitamin C, to be established — despite the fact that cures were discovered time and time again throughout history. Citrus fruit was known to cure the sick when the Crusaders frequently suffered from the disease during the expedition of Vasco da Gama; years later French explorer Jacques Carter used natives’ knowledge of boiling cedar needles containing Vitamin C to make a tea to save his men dying from scurvy — and yet the direct evidence of Vitamin C as the cure wasn’t established until the 1930s.
“Something similar is afoot in financial services today,” said Crosby, who is also president of IncBlot Behavioral Finance, during a Wednesday session at FSI’s Financial Advisor Summit. “We now know because of behavioral finance in the last 40 or 50 years of research, we know that some of the greatest good that an advisor can do is hold the hands of their clients, to manage their behavior.”
As evidence, Crosby pointed to how the market over the last 30 years has returned 11.1% a year while the average investor has held onto less than 4% “because of their bad behavior.”
Crosby said a recent study showed that 77% of financial advisors are talking about behavioral finance concepts — and yet investor misbehavior continues.
In an attempt to cure what ails the financial services industry, Crosby provided ways advisors can help manage their clients’ behavior in the form of 10 commandments:
First Commandment: In all markets, up down and sideways, you control what matters most.
Crosby said that most of the people he’s talked to that have failed to invest in their future haven’t done so because they feel helpless.
“They feel rocked back-and-forth by volatility of capital markets,” he added. “They feel scared, they feel helpless, they feel afraid. They don’t understand that in all markets they control what matters most. That more important than all of this onslaught of information that they’re getting from financial news networks is managing their behavior.”
Second Commandment: Thou shall understand risk.
Instead of the volatility-based notion of risk that everyone is familiar with, the idea of “risk” should be thought of in regards to behavioral finance and goals-based investing.
“Risk is not a number,” he said. “Risk is not benchmark risk. Risk is not underperforming your golf buddy. Risk is the probability that you won’t have the money you need to do the things that matter most to you.”
Even think of risk as volatility as a good thing, Crosby said.
Third Commandment: Start now, start again tomorrow, and start again the next day.
Mathematically, he added, this just makes sense.
“If you’re trying to end up with $2 million in retirement, you’re greatly improving your chances of getting there by starting earlier,” Crosby said. “If you start at 22, you can give $6000 a year. If you start 18 years later, you’re going to have to ramp that up pretty significantly.”
But the other part of this is psychological, by forming and cementing habits in one’s mind.
“If you can get your clients to start saving, deferring, investing, being appropriately aggressive, whatever it is today, they are going to start to cement those behaviors for tomorrow,” Crosby said.
Fourth Commandment: Trouble is opportunity.
Crosby, who has created a 0-to-100 index of market sentiment called the Irrationality Index, talked about when a few years ago that irrationality index reached the lowest point in its history, indicating revulsion with the markets.
“It got down to five out of a potential 100,” he said. “You were there, you understand people’s reactions to this. But, if you had gone in at that 5, by this point you would have about doubled your money.”
To help illustrate this point, Crosby quoted Sir John Templeton.
“[Templeton] had this to say about this concept: ‘The time of maximum pessimism is the best time to buy and the time of maximum optimism is the best time to sell,’” Crosby said. “And we’re all familiar with Warren Buffett’s admission about being greedy and fearful. Trouble really is opportunity.”