Probably: The Most Powerful Word in Investing

Jeff Foxworthy, that loveable avatar of all things backwoods, used to host a TV show called, “Are You Smarter Than a Fifth Grader?” that asked grade school questions of adults who had long since forgotten their lessons. Today, I will be your host on a game show that I call, “Are You Smarter Than a Rat?” Rather than quizzing you on the War of 1812 or long division, you’ll be presented with two lights – green and red – that will flash randomly. Your task will be to determine whether the next flash will be green or red. To make your job that much simpler, I’ll even tell you the odds! The green light will flash 80% of the time and the red light will flash 20% of the time. The rat you are competing against can’t speak of course, so the green light will provide food while the red light will provide a small electric shock.

Consider your strategy for a moment: How would you best determine the color of the next flash with a known 80/20 distribution pattern? Most humans begin the task and immediately begin to look for noise in the chaos: they try to discern a pattern. Which makes sense if you consider Harari's idea that organizing functional fictions into powerful social structures is what separates us from animals. By seeking to create signal in what is truly noise, the human subjects are able to identify the red or green signal 68% of the time. The rats, on the other hand, have no need (or ability) for higher order thinking and quickly learn to just play the odds. Quickly ascertaining that food comes about four times more often than shocks, they learn to guess green every time and end up with an 80% hit rate. The rats have no need to beat the system or craft an elegant story and the simplicity of their “dumb” approach allows them to outwit an ostensibly smarter opponent.

The market analogue of this is evident every time you turn on a financial news channel. Some Ivy League educated market wizard in a $3,000 suit is expounding a complicated macro thesis that interweaves everything from geopolitical threats to potential Fed moves to soybean production. Listening to such a story is hypnotic and rightly impressive; the human ability for higher order thinking and pattern recognition is on full display. But all too often our market wizard is like the human subject in our game show who has over complicated the task by half. The elegance of the story has overtaken the likelihood of its occurrence. The behavioral investor thinks like a rat, caring only for probability in a world that craves sophisticated nonsense. When asked to weave a story on a prominent financial news network, a behavioral investor will have no grand thesis, no series of dominoes waiting to fall. Accordingly, she will never be invited back. Instead, she will pursue a process-driven path of tilting probability in her favor at every turn, secure in the knowledge that “probably” is the most powerful word in investing.

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The Psychology of Value Investing: Why Do We Hate Cheap Things?

To illustrate the behavioral roots of value investing, let us turn our attention to, of all places, the pineapple. As described in The School of Life’s, “Why We Hate Cheap Things” presentation, Christopher Columbus was the first European to taste the pineapple and he was immediately taken with its odd form and acidic sweetness. Columbus tried to transport some of these spiky treasures back to the Old World but they proved hard to ship, which made them exceedingly rare. Accordingly, in Columbus’ time a single pineapple cost roughly $5,000!

Rare and precious as they were, they began to be fetishized by royalty. Catherine the Great and Charles the Second were both noted pineapple boosters, but their enthusiasm was unrivaled by the Fourth Earl of Dunmore who had a temple constructed to honor the fruit. By the 19th century though, things were beginning to change. Large pineapple farms now existed on Hawaii and improvements in transportation technology now made it far easier to transport pineapples. As pineapples become more ubiquitous, they began to be ignored, and now sell for about $1.50. The pineapple, of course, is the same as it ever was, but our perception of its value and even quality are dramatically diminished by its decreased price. It seems unlikely that we savor our fruit salad today with a fraction of the intensity of say, a Catherine the Great

The story of the pineapple demonstrates the close link between price and perceived worth, an idea that was proven artfully by the work of a “horizontal wine tasting” conducted by Stanford Professor Baba Shiv. Shiv had participants lie on their backs in an fMRI machine and gave them carefully titrated doses of wine, each with an accompanying price tag. He then measured the brain activity of the participants as they sipped each of the wines, looking for a relationship between price and cerebral processing. Specifically, Shiv wanted to examine the part of the brain, the ventral medial prefrontal cortex, that we know codes for pleasure.

Sure enough, participants showed more activity in the pleasure centers of the brain when they thought they were drinking $90 wine versus $10 wine. The only problem was that it was all $10 wine! The participants were given the same wine in each condition, meaning the differences in pleasurable brain activity were attributable directly to perceived differences in price rather than the quality of the wine itself. All else being equal, we look to price as the foremost determinant of quality.

For much of our pre-industrial past conflating price and value made perfect sense. Artisans crafted goods by hand and the more care that was put into the creation, the better it tended to be. Today, in a period of automation and cheap access to natural resources, the relationship between cost and value is more tenuous than ever and in capital markets it can be accurately said to be inverse. The more you pay, the less you get. Behavioral investors must create processes that allow them to decouple the spurious mental correlation between price and value and think like a child. A child, who, knowing nothing of the price or provenance of a toy, sets it to the side to engage with the truly interesting part of the gift: the box.

If you liked this article, please check out The Laws of Wealth, named the best investment book of 2016 by the Axiom Business Book Awards.




Dr. Daniel Crosby’s work on applied behavioral finance takes the Gold Medal in the Personal Finance/Investing category.

ATLANTA – Axiom has announced the winners and finalists of THE 2017 BUSINESS BOOK AWARDS on February 15, 2017. Winners were announced in each of 22 business categories with The Laws of Wealth: Psychology and the Secret to Investing Success (Harriman House) taking the Gold Medal in the Personal Finance/Investing category. Awards were presented for titles published between April 2015 and December 2016.

Written by New York Times bestselling author Dr. Daniel Crosby, the prize-winning book aims to be the most practical treatise on behavioral finance written to date. The book is comprised of two parts, the first dealing with the application of psychological principles to financial planning and the second setting forth a practical system for improving asset management by incorporating the latest thinking in behavioral science.

Crosby, a doctor of psychology and President of Nocturne Capital, had the following to say: “For far too long the lessons of behavioral finance have been trapped in the ivory tower of academia and have had limited impact on investors. The Laws of Wealth was written to provide practical tools for managing self and wealth en route to an enjoyable and profitable investment journey. This high honor is a welcome recognition that we are on the right path.” In addition to the critical accolade bestowed by Axiom, The Laws of Wealth has enjoyed a popular commercial reception with brisk sales and a 4.8 average rating on

Founded in 1996, the Axiom Business Books Award was created to “bring increased recognition to business books and their creators”, who may otherwise be overlooked in a publishing landscape that tends to focus on creative writing. Winners traversed the publishing landscape: Simon and Schuster, Pearson, HarperOne, Portfolio/Penguin, Harvard Business Press, MIT Press, Harriman House, Wiley, McGraw Hill, Penguin Random House, and many more contributed to this year’s strong competition. is behavioral asset management firm serving the needs of individuals and institutions committed to the research-based investment principles set forth in The Laws of Wealth.

Dr. Daniel Crosby is the President of Nocturne Capital and an executive at the Brinker Capital Center for Outcomes, a financial advisor education initiative that helps advisors understand the powerful impact behavioral science can have on their practices. Crosby was previously named to Investment News’ prestigious “40 Under 40” list and is the co-author (with Charles Widger of Brinker Capital) of the New York Times bestselling, Personal Benchmark.

A complete list of the winners and finalists of The 2017 Best Business Book Awards are available online at

The Behavioral Benefits of ESG and Socially Responsible Investing

I am a son of the American South and a student of her often troubled history. A native Alabaman, I now live in Atlanta and only recently became aware ofan instance where Coca-Cola used corporate power to do social good in the Civil Rights Era. In 1964, Dr. Martin Luther King Jr. had just been awarded the Nobel Peace Prize and the city of Atlanta was preparing a formal dinner befitting of this great honor. Invitations went out to the city’s elites but almost no one responded. Worried, Atlanta Mayor Ivan Allen expressed his concerns to Robert Woodruff, the former president of the soft drink giant and still one of the most powerful people in town. Woodruff acted swiftly and the Coca-Cola company sent the following message to the movers and shakers of Atlanta:

“It is embarrassing for Coca-Cola to be located in a city that refuses to honor its Nobel Prize winner. We are an international business. The Coca-Cola Co. does not need Atlanta. You all need to decide whether Atlanta needs the Coca-Cola Co.”

Tickets to the dinner sold out within two hours.

This, as we commonly understand it, is the benefit of values-based investing; we invest in companies that operate in accordance with our values and it makes the world a better place. This value is well understood and undeniable, but it masks a less-recognized truism: I believe that values-based investing can actually help us make better investment decisions.

The Problem

While most investors assume that externalities like Fed moves, market volatility and (sigh) the Presidential election are the best predictors of whether or not they will reach their financial goals, the research is unequivocal you (yes, YOU) control what matters most – your behavior. Decisions like dollar cost averaging, staying the course and managing fees are far better predictors of crossing the financial finish line than the aforementioned externalities, but the unsexy nature of this truth means that it is widely ignored.
As Gary Antonacci notes:

“Over the past 30 years ending in 2013, the S&P 500 had an annual total return of 11.1%, while the average stock mutual fund investor earned only 3.69%. Around 1.4% of this underperformance was due to mutual fund expenses. Investors making poor timing decisions accounted for much of the remaining 6% of annual underperformance.”

This “behavior gap” is so meaningful that many investors are taking risk only to fail to keep up with inflation! This realization has spawned numerous books (The Laws of Wealth by Dr. Daniel Crosby is available at fine booksellers everywhere!), countless conference speeches and has resulted in two Nobel prizes to date. But for all of the attention that bad investor behavior gets, it remains fairly recalcitrant to intervention. Educators teach, advisors cajole but following fearful and greedy impulses is a hard habit to break. After all, obesity has risen dramatically since nutrition labels became commonplace in the 1990s. Even when we know we’re not acting in our best interest, being irrational can be so delicious.

The Power of Personalization

Education has tended to fall short of producing the desired behavioral results partially because it occurs on the periphery. With the exception of the much more effective, “just in time” behavioral coaching, education occurs in a cool, rational moment that has little power over a fearful mind in the throes of market volatility. Perhaps that is why there is some evidence that embedded solutions have greater potential influence. Specifically, when a portfolio is comprised of holdings that the investor finds more personally meaningful, it seems possible that this would have the impact of positively shaping behavior.

George Loewenstein had this to say about labeling investment “buckets” according to the actual life purpose they are meant to meet:

The process of mentally bucketing money in multiple accounts is often combined with earmarking the accounts for specific goals. While it seems like an inconsequential process, earmarking can have a dramatic effect on retirement saving. Cheema and Soman (2009) found that earmarking savings in an envelope labeled with a picture of a couple’s children nearly doubled the savings rate of very low income parents.”

As the buckets of money became less abstract and more personally meaningful, behavior is changed and improved.

Consider too the experience of SEI Investments, who had clients in both goal-based (which is to say, benchmarked to their personal goals and return needs rather than something like the S&P 500) and traditional strategies at the time of the 2008 financial crisis. They found the following distinctions among the two crowds:

Of those in a single, traditional investment portfolio:

·  50% chose to fully liquidate their portfolios or at least their equity portfolios, including many high net worth clients who had no immediate need for cash.

·  10% made significant changes in their equity allocation, reducing it by 25% or more.

Of those clients in a personally meaningful goals-based investment strategy:

·  75% made no changes.

·  20% decided to increase the size of their immediate needs pool but left their longer-term assets fully invested.

SEI’s key finding? “Goals-based investors are less likely to panic and make ill-informed changes to their portfolios.” It is intuitive philosophically that a personalized approach would reduce panic, but seeing such dramatic results play out empirically is satisfying indeed.

A Potential Solution?

The evidence seems to suggest that as our investment lives take on a more personalized touch, our behavior changes accordingly. Framing saving as a future benefit to a beloved child rather than a current loss of opportunity is a powerful incentive to save. Benchmarking to the returns we need to do (YOUR DREAMS HERE) keeps us in our seat when those benchmarked to the broad market are losing their cool.

Similarly, I believe that investing in ways that correspond with our values will make investment management more real, more personal and possibly incent us to do the hard work of remaining patient and committed. It is my supposition that a devoted Catholic would be far less likely to sell an Ave Maria fund than a more generic alternative when volatility strikes. Similarly, an accomplished female executive may feel a personal attachment to a “Women’s Leadership Fund” than a fund that met a comparable risk/return objective. In both cases, one is an abstraction while the other is a concrete representation of deeply held values.

The relationship between values-based investing and behavior will of course be complicated and may even have some negative consequences. After all, emotion can obscure rational thought just as surely as it can compel positive behavior. But I for one remain hopeful that as we improve our awareness of how our investment impact the world around us that our behavior will improve in kind.


Dr. Daniel Crosby is the President of Nocturne Capital and the New York Times bestselling author of The Laws of Wealth.






Two Free Chapters of The Laws of Wealth

My publisher, Harriman House, has graciously agreed to let me distribute the Preface and a sample chapter of The Laws of Wealth to allow you to "try before you buy." The sales and the critical response to the book have exceeded all of my expectations and I'm grateful for this opportunity to continue to spread the word. Please enjoy your free chapters, help spread the word and consider purchasing the book here. Thank you! - DC