Ideas

The Limits of Willpower and What it Means for Investors

This week on the podcast we tackle the evidence for and against willpower and free will and discuss the following:

  • Would you have helped Anne Frank if you had been alive during Nazi occupation?
  • Why do people who drive Audis make such poor spouses?
  • What causes willpower to be depleted?
  • What should our understanding of the limits of willpower mean for the way that we manage money?

To listen to this latest edition of the Money, Mind and Meaning Podcast please click HERE and don't forget to rate, review and share to help us spread the word. Thank you!

Of Running and Investing

Two years ago,  I crossed off a personal goal when I completed a half-marathon. I have jogged a bit for years, but in a moment of New Year’s induced insanity, I committed to run 13.1 miles in front of my friends and family, ensuring that I’d never live it down if I failed to finish. The race itself was very difficult for me and I found myself looking for mental detours to distract myself from the blistering and chafing that accompany long distance running. In this state of mind, I turned to a consideration of the ways in which road racing is like investing, a portion of which you’ll see below:

Purpose matters – The marathon in which I participated came about after a father of a child with Down syndrome and a heart defect promised his son that he’d run a marathon for him if he’d just pull through those tenuous first days in the hospital. Accordingly the proceeds from the race are donated to a local charity involved in early intervention programs for children with special needs. As a result of the charitable aims of the race, many people were there running for a purpose. Some had pinned pictures of their loved ones to their shirts, others wore headbands that spoke to their cause and I even saw one couple running for the memory of their deceased dogs.

In investing as in running, framing the endeavor in terms that are personally meaningful to you can have an enormous impact. George Loewenstein says of this concept, “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.” Saving for what is essentially 25 years of unemployment can be awfully hard if you don’t know why you’re doing it in the first place.

Run your own race – Much like many rookie runners, I began the race overconfident and did not adequately pace myself for the rigors facing me later in the course. I took glee in passing people and hanging tough with those who were clearly more physically fit. But not having accounted for my own strengths and limitations, my strength began to flag when I encountered a series of uphill climbs for which I had not prepared. Soon, I was passed by those I’d bested a few miles back and my elation at having outrun them earlier soon turned to despair at having fallen behind.

The parallels to investing here are painfully obvious to recognize but difficult to implement. The race was comprised of marathoners, half-marathoners and even relay teams of runners who would only be running six miles apiece. Add to that the various levels of fitness, experience and training and the pack becomes diverse indeed. Being built more like a nose tackle than a West African sprinter, my goal was simply to finish and not die, a goal I soon lost track of in the collective fervor of the crowd. There is simply no such thing as a one-size-fits-all approach to investing and those who watch benchmark performance at the expense of their personal benchmark risk burning out just as I did.

Find support – As a psychologist, I should no longer be surprised at this, but the most incredible part of the whole process to me was the way in which I was buoyed up by the support of those lining the streets. Priests and altar boys stood in full regalia handing out orange slices. An adolescent boy grinned impishly as he held a sign that said, “One percent of marathoners poop their pants, smile if you’re the one.” And the little girl, about my own daughter’s age, with a crudely drawn print of her own hand that said, “Touch here for power!” As I approached the girl’s sign, my pain-wracked face lit up with a smile as I made my way over for a quick shot of power. As I touched the handprint, I felt something palpable well up within me that gave me strength, real strength to push forward.

A recent Aon Hewitt study found that investors who worked with advisors during the Great Recession outperformed those who did not by 2.92% net of fees. This is not necessarily because financial advisors are especially adept at stock picking or financial forecasting. Instead, the best advisors realize that the greatest gift they can give their clients is the gift of behavioral management. If your advisor has saved you from five bad decisions over the course of a 20 -year engagement, she has done her job and then some. A skilled advisor is like those people along the course that saved me. Ready with good advice when you need some, but just as generous with an encouraging word and a pick me up when you are at your weakest.

Notwithstanding the fact that I could barely walk two days later, I know that I’ll be back to run another race soon. Much like investing, running gets in the blood. But in both endeavors, finding support, running your own race and doing it all for reasons that matter deeply to you are the key to long term success and enjoyment. 

To learn much more about the intersection of mind and markets, please check out The Laws of Wealth by Dr. Daniel Crosby - HERE

The Best Books on Behavioral Finance and Behavioral Economics

It seems as though I get asked just about every week, "If I want to learn more about behavioral finance, where do I start?" So, in an effort to give a more comprehensive answer to that question (and save myself some time), I've compiled the list below. Happy reading!

The Bible(s):

The Laws of Wealth - Crosby 

Thinking, Fast and Slow - Kahneman

Irrational Exuberance - Shiller

Nudge - Thaler and Sunstein

Antifragile - Taleb

Introduction to Behavioral Finance:

Why Smart People Make Big Money Mistakes - Belsky and Gilovich

The Little Book of Behavioral Finance - Montier 

Predictably Irrational - Ariely 

Misbehaving - Thaler

Animal Spirits - Akerlof and Shiller

History of Finance:

This Time is Different - Reinhart and Rogoff

A Short History of Financial Euphoria - Galbraith

Biology + Psychology + Investing:

The Hour Between Dog and Wolf - Coates 

Goals-Based Investing:

Personal Benchmark - Crosby and Widger

Risk:

Against the Gods - Bernstein

Decision Making:

The Checklist Manifesto - Gawande

The Investor's Paradox - Portnoy

The Paradox of Choice - Schwartz

The Power of Fifty Bits - Nease

Think Twice - Mauboussin

Behavioral Investing:

Quantitative Value - Gray and Carlisle

Behavioral Investment Management - Davies and Servigny

Value Investing - Montier 

Behavioral Portfolio Management - C. Thomas Howard

The Most Important Thing - Marks

The Little Book That Still Beats the Market - Greenblatt

A Wealth of Common Sense - Carlson

Dual Momentum - Antonacci 

What Works on Wall Street - O'Shaughnessy

Contrarian Investment Strategies - Dreman

The Intelligent Investor - Graham 

You Can Be a Stock Market Genius - Greenblatt

A Random Walk Down Wall Street - Malkiel

Probability:

The Signal and the Noise - Silver

Fooled by Randomness - Taleb

The Black Swan - Taleb

The Drunkard's Walk - Mlodinow

Women + Investing:

Women of the Street - Jones 

Warren Buffett Invest Like a Girl: And You Should, Too - Lofton

Best Expose:

Backstage Wall Street - Brown 

Affect Heuristic - How Emotion Can Get the Best of You

One of the reasons psychologists can charge $200 per hour to ask, “how does that make you feel?” is because we have become great at putting fancy-pants labels on things that would otherwise be very intuitive. Take for instance the tongue twisting “affect heuristic,” which is simply a reference to our tendency to perceive the world through the lens of whatever mood we are in.

For example, when giving a seminar on risk assessment, I often ask participants to write down the word, that if it were spelled phonetically, would be “dahy.” Go on, write it down and don’t over think it. It turns out the way you spelled the word has a lot to do with the kind of day you are having. Those that spelled the word as “die” may need a hug, while those that spelled the word “dye” are probably doing fine.

Ask someone having a bad day (those that wrote “die,” I’m looking at you) about their childhood and they are likely to tell you how they were chubby, had pimples and never got picked first for kickball. Conversely, ask someone having a good day about their childhood and they are likely to recall summers in Nantucket and triple dips from the Tastee Freeze. Memory and perception are moving targets colored by our mood, not infallible retrieval and evaluation machines through which we make unbiased decisions.

So what is the moral of all of this psychobabble? Think back on the last time you went shopping when you were hungry. Once you’ve brought that to mind, think back on the contents of your shopping cart. If you’re like me, you probably had a whole mess of HoHos, DingDongs, Nutty Buddies and Diet Coke (you don’t want to get fat, after all), but nothing very healthy or substantive.

The same rules apply to any life decision requiring risk assessment; if you try to make decisions when you are happy/sad/angry/in love/anxious/worried/euphoric, you are likely to end up with a life full of junk. When speaking to investors about the affect heuristic, I borrow an acrostic from the addiction literature - H.A.L.T. - which stands for hungry, angry, lonely or tired. The 12 step and other programs encourage those in recovery not to make decisions when they are in any of the emotional states described in H.A.L.T. and this advice is just as sound for investors. You do not view investment risk independent of your emotional state and so making long-term financial decisions in a short-term elevated emotional state should be avoided altogether. 

To learn much more about the intersection of mind and markets please check out The Laws of Wealth by Dr. Daniel Crosby - HERE