Emotions impact every financial decision we face and sometimes it causes us to make choices out of fear or greed.
Today on the show the guys talk to Dr. Daniel Crosby, a psychologist, behavioral finance expert and asset manager.
He is the co-author of the New York Times bestseller Personal Benchmark: Integrating Behavioral Finance and Founder of Nocturne Capital. In Daniels’ latest book, The Laws of Wealth, he talks about principles for managing your behavior and how emotion and psychology influence our financial decisions.
What is behavioral finance?
The concept of behavioral finance is a fairly new idea that looks at behavioral, psychological theory together with economic explanations for why people make irrational financial decisions.
Why do so many smart people making the wrong choices with their money? Daniel wants to find out what causes some people to behave illogically when it comes to finance and how to build investment portfolios based on unvalued investments created by investor’s emotional behavior.
Daniel works as a sort of a financial therapist and asset manager centering his work on helping his clients stay away from making irrational emotion-driven mistakes.
Investors can often be their own worst enemy and are to blame for poor investment returns. Volatility in the market can cause investors to act unpredictably at times – not in their best interest.
You control what matters most
You can’t control the stock market but what you can control is human behavior. Over the last 30 years, the market has returned about 11% a year while the average investor has only held about 4% because of emotional decision making when markets are going up and down.
“Be Fearful When Others Are Greedy and Greedy When Others Are Fearful” – Warren Buffett
Investing needs discipline and rationality. Being in control of that takes planning and executing. Take your power back and gain control of your situation no matter is going on in the markets. Set up systems for yourself and follow simple rules of thumb so you mitigate potential harm to your financial lives.
Daniel believes you cannot do it alone. People who work a financial professional tend to do 3% better than people who don’t. Advisors don’t have all the answers, but they can help you not to make emotionally driven mistakes.
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Do you want to be average?
Two of the well-known investment styles are growth investing and value investing. Growth investing is investing in stocks that have shown higher than average growth over the previous years, compared to the market average, and show promise to continually grow into the future. They are riskier than average stocks but have the possibility to multiply in value.
The other is value investing strategy. Value investors like Daniel actively seek stocks they believe the market has undervalued. He believes many of these stocks get overlooked due to human behavior and fear.
He finds pockets of disproportionate value which are created by human behavior. The strategy has been used by Warren Buffet for many years.
Daniel takes a quantitative approach to choosing his investments basing his choices on the The 5 P’s – Price (valuation), properties (quality), pitfalls (risks), people (what are the insiders doing), push (momentum/potential growth).
Risk is not a squiggly line
Risk is different for everyone when it comes to investing, and that’s why Daniel believes in personal benchmarking. He helps his clients create a personalized definition of risk and using their top motivations to make better decisions.
It’s not just about the economy; it’s about your economy. He wants to help others improve their personal investment experience while increasing returns.
Don’t compare yourself to others. Figure out what kind of risk you should take that is commensurate with the life you want to live. If you don’t have a crazy lifestyle, you don’t have to set crazy goals and take on crazy risk.