March 16, 2022

Behavioural Investing Series #1 – Transcript

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Behavioural Investing Series

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Fraser Jack
Hello, and welcome to this topics series on behavioral investing where we take a deep dive into client and advisor decision making. My name is Fraser Jack and in this series we hear from a fantastic panel of speakers. First up is award winning financial advisor from Brisbane Patricia Garcia, along with Dr. Katherine Hunt, a lecturer in financial planning at Griffith University. Then we have David Bell, Executive Director, academic and researcher at the Connexus Institute, along with Dan miles Managing Director and CO Chief Investment Officer from Innova Asset Management. All of these speakers bring a unique perspective to the conversation. This is the first podcast in a series of five. In this episode, we dive into the different behavioral biases in investment decisions from recognizing them to discussing them with your clients. In Episode Two, we cover goals based investing. In episode three, we tackle values based decision making. Episode Four is all about client risk profiling and advisor investment philosophies. And rounding out the series we take on the not so modern portfolio theory, discussing traditional strategic asset allocation or SAA versus dynamic or risk defined portfolios. But stay tuned now as we lean in to recognizing different behavioral biases.

Thank you, everybody, for joining us here today. I’m speaking with Katherine and Patricia, thank you both for joining me. And we are talking about behavioral biases in investment decisions and decisions in general. Thank you both for joining me, Katherine, as we approach the subject, what what are your initial thoughts?

Dr. Katherine Hunt
There’s so much research on our inability to use our own brains basically. So as a heap of research on judges for, for example, they are professional decision makers, that is their job. They make decisions all day, they cannot make good decisions. So for example, they have these parole, parole board meetings. It’s binary decision, you’re either going to get parole or not. And in the hour before lunch, how many people do you think get parole? Yeah, no one. No one gets parole? Oh, no, what? And they’ve got they’ve heard this data over hundreds of 1000s of instances, because it’s a binary decision. And it’s, it’s in every country as well. So there’s a heap of data on it. And it’s all recorded. So not no one. Obviously, that’s a bit extreme for comic effect. But then, after lunch, who goes out who gets parole? Oh, everyone, everyone gets parole, because they go to full Tommy, they’ve had to be around the lunch. They’re ready. They’re good to go. And these are professional decision makers. So we are useless at using our own brains, no matter how educated we are. And I mean, people like Patricia, and you you’re so highly educated, so experienced, and probably you think, Huh, I’m pretty good at making decisions and using my own brain, though. But if we look at the data as a whole, it looks like no, none of us are really that good at all. So it’s super interesting context.

Fraser Jack
I’ve always had this idea that, you know, we may have we make emotional decisions. And you know, logic, the logic doesn’t come into it. But one of the things I haven’t really considered is, is whether you’re hungry or not. So that’s, it’s an interesting part of the conversation. It shows you from a from a bias point of view, obviously clients come into your office. So with predecease ideas around what they might be doing.

Patricia Garcia
Oh, yeah, all the time. We all have them. Like Katherine said, I have the we have them. We all have them. I think it’s why we need professional people around us helping us make decisions is because those foot professional people have the skills and the ability to make better decisions. by taking the emotion out of it, so even when I’m helping clients make tough decisions, it’s tough for me, even though it’s not my life, you know, they just, they’re my clients. And of course, I have their best interests at heart. But it can sometimes be tough is not always black and white. But I can be a lot more logical, and I can take the emotion out of it a lot better than they can. So that’s our job. You know, behavioral finance is all about trying to get to know clients and trying to pinpoint where their, I guess, pain points are, and where you think that there will be more buyers and trying to remind them of different things that they’ve done in the past that perhaps didn’t turn out as well as they thought to help them make better decisions along the way,

Fraser Jack
Katherine, one of the things that Patricia mentioned there was around when clients, you know, helping clients make decisions is that sort of not just about logical information, and you know, what’s in their best interest, but the fact that that advice can come at this from a disassociated state, you know, they’re not actually in the, in the head of the person who’s they’re giving advice to?

Dr. Katherine Hunt
Exactly, exactly, it’s exactly, as Patricia said, the power of being detached in a way. So on the one hand, someone like Patricia is so invested in her clients getting the best outcome, but on the other hand, she can take a couple of steps back, look at it from a strategic perspective, look at the client’s nuances and their own issues, hang ups, historical challenges that they’ve overcome, and the whole weight of the emotional situation there. And so she can help the client to navigate their own emotional problems, I suppose around decision making. So that having that third party available to help you with decisions, is one of the main reasons I think that that people actually seek a financial advisor to help them with something that you know, in a way they might be able to do it themselves, if they had the self control and the attention to detail and the ability to detach, and they can’t, because we can’t, because we’re human.

Patricia Garcia
Yeah, it’s interesting. Just yesterday, I had a meeting with a client. And he called and he said, I’ve got an investment opportunity, my daughter is going to university, and we’re going to potentially get some benefits from the VA. So he, he used to be the army. But regardless, the point was, he thought all the rent will be free. So we should definitely buy a property for her, because she’ll then give us the rent. And I, and he was convinced that that was a great decision. And all I had to do is step back into the numbers. And I said, it doesn’t matter if it’s coming from her third party, it’s still coming from a third party. And we work through it. And he’s like, Oh, I can’t believe that. You know, he was a bias towards wanting to help his daughter, and couldn’t even consider simple mathematics of money money out either positively or negatively. Good. So that’s just a simple example of something that can be so simple that anyone can do their, you know, a smart person didn’t think, to walk through those steps because they were emotionally biased towards helping their you know, that child.

Fraser Jack
Yeah, this is an interesting point, isn’t it? It’s about that emotional bias could could be financially not in the clients best interest, but yet still be exactly what they want to do. You know, which might be in their emotional interest or, or the thing that they get the most joy or pleasure out of, of doing what are your thoughts, Katherine?

Dr. Katherine Hunt
Yes, as we know, best interest duty actually requires us to do what’s in the best interest of the client, regardless of what the client wants. So that interplay is really interesting, because often what the client wants, you know, they might want to give 90% of their wealth away. And we might be able to quantify and say, Look, that’s probably not a good idea, because you won’t have enough then to even pay rent, we have to work towards the clients goals on the one hand, but on the other hand, their goals might not be what really is the best thing for them. So it’s a it’s a complicated scenario, when what they want is, or what they say they want kind of requires a little bit of discussion, just like how you said before Patricia, about discussing with them and really doing the goal exploration. Okay, so this is what you want, and why do you want that are great, okay, let’s achieve that same outcome on a different path.

Patricia Garcia
Yeah. And actually, that’s how I finished off with this current chair, in this case, they could afford to do it. And I said, Look, so mathematically, you know, this is how it will play out from a cash flow perspective. But are you doing it because of it’s because of it being an investment opportunity, which is how you started this conversation? Or are you doing it as a lifestyle decision to help your daughter that’s a different discussion. Yeah. So, you know, go away and think about that. And that’s how we ended the conversation. So it’s interesting to see how just, you know, 15 minutes it can go from no, this is a great investment to actually, is it a good investment? What Why do I actually want it and help them think through that?

Fraser Jack
Yeah. So Katherine, I was thinking also, you know, what are some of the main biases that that humans go through when obviously, their past their their history, that anything that scared them in the past often is one of the main things that come up. But from a, you know, consumer point of view, or an even an advisor point of view, what are some of the things that do, you know, jump out has been clear behavioral biases.

Dr. Katherine Hunt
So if you’ve had a look at the list of behavioral biases, it’s almost like they have a term for every decision you’ve ever made, even if it’s a unique decision, and you think you’ve only ever made that decision once. There’s a term for it. So there’s so many of these biases that these economists have been studying. But in general, anything where you’re using your emotion to make decisions become can become a behavioral bias, which is, it kind of sounds like it’s a bad thing. But if we didn’t use our emotion to make decisions, our brain, our tiny little primate brain would be so overloaded, we’d be on the floor in a coma, like we cannot process all of the information that we have available. Even for the 10,000 decisions we make every day, we can’t do that consciously, our brains are too small. So we need to use the emotion. And it’s just the fastest path for decision making. So any any historical event, it can be something mundane, like you’re walking through a shopping center. And on the screen, you see the tagline of a news event that can prime you for something. So the types of behavioral biases cognitive biases that come up are just everywhere, basically, especially in decision making, for in financial decision making, so like my favorite ones include sunk costs, that’s probably one of my favorite ones, one of the logical fallacies because it’s, it’s kind of easier to pull apart and quantify in a way, but there’s so many it’s like, confirmation bias is obviously a very famous one that we all suffer from. And a great example of that is Bitcoin, because we all have a perspective on it. And we basically all use new information, and reinterpret the new information to confirm whatever we already thought about because,

Fraser Jack
yeah, that sounds exactly how social media platforms are working anyway, they all work out what you like to hear and give you more of it. Exactly. Patricia, what are you seeing is the main sort of biases, from clients or even advisors,

Patricia Garcia
I think it’s important for advisors to recognize their own biases, and potentially attract the clients that meet those biases in a way. So a simple example may be, you know, active versus passive investment philosophies. Some advisors can have a strong preference one way or another. But it’s about being really clear about that, and making that clear to our clients when we’re dealing with them, to make sure that it suits them because there is no right or wrong. It’s a matter of preference and an education, a range of different things. But if you’re not transparent about that, and all you’re doing is constantly influencing clients towards the same outcomes, that can be something that we, you know, as advisors could be guilty of. So we need to be conscious of that. I think, from a client’s perspective, some of the big biases that I see around, you know, the most common one is you want to continue investing and buy when things are going out, and you want to sell and things are going down. You know, when markets are volatile, oh, you know, this is not such a great investment. And then markets really are not want to sell anymore, they wanted to sell last year, and then now markets have gone up. So they they’re going to get more for more money than they did before. And now they don’t want to sell anymore. So for me, it’s always about what I always say to clients is we need to decide what the plan is, and what the strategies what the right investment options are. And then you have to stick to the plan unless something significant changes because short term volatility shouldn’t influence that. It’s a long term plan. If your goals change, and if your behavior actually significantly changes and you’re, then perhaps something needs to change. Apart from that we need to do those things before the volatility happens so that you make the right decisions when the volatility actually, when you’re actually in the midst of that.

Dr. Katherine Hunt
It’s really great that you have those strategies. So I can imagine that navigating the clients by As must be almost impossible, Patricia, because especially Okay, at the moment, obviously it’s prime to market volatility, but navigating that amongst the fact that they’re, they’re actually going to be worried at some point, they’re going to see their portfolio value and think what is going on here. They’re going to be severely affected by these the biases, but also just about their, their personal risk aversion, loss aversion in particular. So how do you actually manage that, like, surely when you say to them, okay, we’re just going to stick to the plan, and we’re going to manage this before the volatility comes? There’s more to it than that, surely?

Patricia Garcia
Yeah. As a great question. I think I’m really fortunate that my entire careers and advisor has been around advisors and clients that don’t focus on investment returns. And it’s always been around goals. And also starting my career right after in the midst of the GFC, the global financial crisis. So I lived through that ready, and I saw their behavior. And I think one of the greatest things that I’ve learned from it, that I do with my clients is that from the moment I meet them, I tell them, your portfolio will drop significantly one day, we just don’t know what that when that day will be. So we just need to set it up for that to happen. And then I try to use reverse psychology in a way not reverse psychology, but for example, their wealth created to say, instead of not wanting that, that’s what you want, you know, you’re buying, that’s what you want, we want market volatility, that’s what we want. And then for retirees is saying it’s going to happen. That’s why we’re going to have to give up on some returns and have some defensive assets. You know, I talk about sequencing risk, and I show them how chasing higher returns will actually lead to lower returns in, in actual returns are they going to experience which is what matters is our market returns is their returns. And I go through that education process. And I pray, you know, we preempt all that. So when it happens, we go, Oh, that’s okay, we’ve got that in their bucket for for that we can write it out. And that’s what you know, you have to constantly remind them of that, and I remind them of that at every meeting. So every meeting, we say, we don’t know what’s going to happen, but it’s going to happen, we don’t know what’s gonna happen, what’s going to happen. So they they get really used to that,

Fraser Jack
I really love this pre framing of you know, that dip in the market and understanding that that you know, is going to happen, we know it’s going to happen. But then when it does happen, they go there. It just also cements that effect that oh, you told me that was going to happen so even deepens the relationship that they have with you. I want to go back a little bit to something that you mentioned earlier was around the the advisors, understanding what their own experiences and turning that into a business or investment philosophy or whatever it might be, and understanding that they have been through my like exactly the same as your experience, your experience has been, you’ve been through the GFC. And now you know these things, but to harness those opportunities to build that into their business as a, you know, business philosophy and something that, you know, they can highlight rather than just sort of, you know, skirt around. What are your thoughts, Katherine?

Dr. Katherine Hunt
Something that does kind of does worry me a little bit is when I come across advisors that, oh, no, it’s fine. It’ll be fine. They will be fine. When the market volatility comes. And you know, they haven’t talked to their clients ahead of time, like Patricia has. So being upfront, and really transparent about that. I think that’s so important.

Fraser Jack
Patricia, what are your thoughts on the idea of, you know, experience, the experience of being through forming part of, you know, your investment or business philosophy around and communicating that to clients before they come in?

Patricia Garcia
Yeah, I personally don’t have strong view, for example, in relation to passive or active. I go through both with clients. So in that sense, I guess it’s easier for me because I don’t feel I’m significantly biased in that way. But I explained the differences to them and the fact that you can also do both and, and then with that’s how we help them build portfolios. The difficulty, I think, is actually how much detail do you give clients, you know, getting a client on board, like you’re ready, literally giving them a master’s degree in financial planning and in you know, three months, over four meetings. It’s actually quite difficult to cover everything off. And is also it can be overwhelming if you if you give too much information. So I think the key is to actually give the really important information and keep educating along the way and reviewing along the way, and giving a bit more every time and and essentially trying to determine what what do they need to know to drive the car, they don’t need to know the engine. So that’s how I approach it. But yeah, with with our business, we don’t have a strong philosophy around active versus passive. But I discuss different options with clients and help them build different portfolios. And I tried to, to remind myself of my own biases as well. And try to make sure that I’m addressing it twice as much when I’m when I think I’m in that space, just to make sure I’m not potentially influencing them in a way that they wouldn’t normally be influenced.

Fraser Jack
Yeah, well said, Catherine, one of the other things I wanted to ask you about was just the the bias around now versus later, you know, the idea, the whole idea of superannuation was, you know, putting money away, but people never really engaged with it. We always think about the now it’s very hard to, to put the, you know, to prioritize later over now, tell us what, what are your thoughts on this bias,

Dr. Katherine Hunt
people have different levels of their, basically, their present bias is what we call it in the research. So the bias towards the present. And we’re all a little bit different. It says, they haven’t really figured out why we’re all different. But some of us are very focused on now. And some people are focused on later. And it’s really one of the underlying biases with regards to anything financial, isn’t it because no success happens today, tomorrow, or the next day, even, you have to have the vision, you have to have the 510 Year Vision for anything for building a business building a career, investing, achieving goals, it doesn’t matter what it is, you have to have a long term vision, and we’re just not very good at it. Basically, most of us have a very strong bias towards the present. And we just we have a simple way of testing present bias as well. So we, we say to them, we have like a list of numbers, basically, and take what you would prefer $50 Today, or $80. Tomorrow, and of course everyone thinks the ideal is tomorrow. Okay. $50. Today, $80. Next week, most people still pick $80. Next week, move it down to six months, though, $50 Today, or $80 in six months, and you’ll start to see people choosing $50 today. So that’s at the point at which people shift, how long is it in the into the future that you’re going to start prioritizing today. That’s the point that we, as academics are interested in the point of the shift of No, that’s too long, I’m not going to wait six months for $30 on $50 return. So that’s present bias.

Patricia Garcia
And that’s really interesting. I know how to recognize that in my clients straightaway, the especially the ones that are at the extreme ends. I you know, as you’re speaking, I’m like, Oh, these client is definitely viewed the today client, or these clients, definitely tomorrow a client. And I think my job as an advisor is to help bring them back a bit more balanced. So I can I’m thinking of two people right now. And, you know, one of them’s like, not nothing’s ever happened to me, and I’m gonna die young, and I want to enjoy today. And I kept like, you know, saying, Oh, actually, you know, you’re probably going to live long. And you know, I keep trying to get them to understand it actually, for many, many years, they have changed significantly, it’s quite interesting to see the shift how, how different he is today to what he was eight years ago now when he started with us. And then I’ve got another client that just wants fans, and he’s like, What do you know, who are you leaving all this money to, and the wife might complain that she wants a few extra things. And he just like really, you know, wants to say even that’s his personality. And then again, I keep reminding them, I actually can afford to spend a bit more. And this is why and we go through that. And like slowly, you might see them spend a little bit more. So it’s interesting to see the differences. And I think our role was just to make sure that we’re being really transparent with them of the impact of those decisions and keep reminding them and educating them so they can potentially change slightly. Once they get more educated, more comfortable.

Fraser Jack
Yeah, Patricia, one of the hard things has always been managing different personalities. And in a couple in that respect, often that it’s not spoken about at home, and then they come into the office and you’re asking questions that are difficult to articulate. And then they find out that their own different pages with those particular things. How do you go about from a practice point of view and having those conversations with people that have different points of view?

Patricia Garcia
Hi, yeah, that’s interesting. I think I haven’t ever had something where you really just had to go you know, I can’t help you. This is two contradictory that. If I if We go this way I’m helping you. But if we go that way, I’m helping her, let’s say, so I can’t really help any of you, because that’s not going to be in both of your best interests that I think in my experience, it’s just been a matter of just helping them have that discussion at that point in time. And then helping them, you know, sometimes they might, okay, we’ll go home, and we’ll talk about it, we’ll come back to you. And they come back with what they actually want, after they thought about it more, helping them understand, you know, each other’s point to points of view, and the impact of you know, if we do what he wants versus what she wants, this is the impact. This is the outcome. This is the these are the risks, the advantages, disadvantages, I think that that’s what Yeah, our job would be and then obviously, identifying when you can’t, you can’t give them an advice, because you wouldn’t be acting both that, you know, in the best interest of both of

Fraser Jack
them. Yeah, it’s a tricky one, it probably falls into some of the ethical stuff that you’re doing. Catherine, what are your thoughts on on that area?

Dr. Katherine Hunt
Yeah, the the couple dynamics as well, I think it’s overlaid on gold exploration. So I can imagine, Patricia, that when you have that discussion with them, that, okay, let’s figure out your goals. And the discussion is kind of one of them says, Oh, well, we want to travel the world and the other ones like travel. I want to spend time with my grandkids, or whatever that looks like. And there’s just kind of, it’s not necessarily a stark conflict of interests, like the kind of relationship differences that could actually result in you not being able to serve the clients. But more just on the relational level of almost like a marriage counselor in a way does has that? Does that kind of come up in some of your client meetings where you feel like you are the intermediate, intermediate anyway? Yeah.

Patricia Garcia
It doesn’t happen to the majority of clients, but I’d say he happens to 30% of clients maybe. And it’s around, what are your goals? Someone has a goal that they want to go traveling and you know, 30 $40,000 when they retire, big trip, and then you review it again, like oh, no, I don’t want these and then she, like, go out on these. And you know, that person doesn’t want it. And it’s quite interesting, because sometimes, especially if they’ve been clients for a while, they like, they’ll sit there, I actually had this week as well. They’ll sit there and talk to each other and not talk to me for like, sometimes 510 minutes. And you just like just watch. And it’s quite interesting to see them work through it. And they’re like, literally, there has been like a mini fighting fraud. And this guy was like, Oh, you never you always get your way or you know, okay, I’m not gonna get it again. And like, literally having this fight is quite funny. But eventually they’ll work through it, and then you can see the compromises, you know, he will get these and then she will get that. So, it’s quite interesting. And then yeah, again, I sort of jump in on it to reaffirm, you know, what’s what you know, you can or you can’t do this, I know there’s achievable, not achievable, or this will be a significant change, we have to check the impact versus not. So sometimes I find that, yeah, I am sometimes encouraging clients, especially your older clients to spend a little bit more, you know, enjoy life a little bit more, and remind them that they can affect what they choose to do.

Fraser Jack
I love I love your stories, Patricia, it’s a really is another example of the true value inside of financial financial advice. Just the clients having those conversations with themselves that they would never have at home. So it’s brilliant. Katherine, Patricia, thank you so much for being part of this particular episode, we look forward to jumping back into the conversation with you guys, when we start talking about goals based investing.

Thank you for joining us. This is the first episode of fire that we’re talking around mister behaviors and investments and decision making and a whole lot of fun topics. I’m joined by Dan and David. Thank you, gentlemen, for joining me. Dan, I might start with you were talking about the concept of behavioral bias in investments decisions and obviously that can be could mean investors or or investors as in the consumer or the investment manager. Then tell us about what your idea around some of the behavioral biases that affect our decision making.

Dan Miles
Yeah, I mean, there’s there’s some of the obvious ones that people are aware of short termism. You know, responding to failing grade anchoring, which is essentially taking an arbitrary figure and then making a decision around that, that short termism component, you know, looking at what’s happened in the recent past and assuming that that’s what’s going to occur in the future. And one in particular that we have a fair bit of focus on is what’s typically referred to as mental accounting that is probably easier to understand. Usually, it’s referred to as bucketing where, where people you know, put different markets and different pools of money into you know, just mentally, so that I can think about it in a more structured fashion. And some of these biases, yeah, we know that they can be very destructive. But our belief is that if an advisor is equipped and told and educated and they go into client meetings, understanding some of these biases that they don’t necessarily have to be very disruptive, they can be value accretive. So if you don’t mind me talking about one example of that, mental accounting is one that I think is a perfect one where it where the theory is that if you have a series of different portfolios that you know, combined, it’ll either end up looking like a Balanced Fund, or it won’t end up being an optimal portfolio. But the reality is, an optimal portfolio can only ever be built in hindsight, it can’t be built in foresight, unless you had a perfect crystal ball. But if a client is able to, if you’re able to take advantage of that, that bucketing approach, and segregate their goals, prioritize their goals and have a look at the different time horizons, you can then get a better assessment of the amount of risk, whether that’d be risk aversion, or that, you know, risk tolerance, risk capacity and potentially need, you can you can help them construct a portfolio that’s more appropriate based on those series of goals. And on top of that, they then have a much greater understanding as to why they own the assets and the amount of risk that they’re taking to achieve those particular outcomes, which is where I think it can actually be quite beneficial, where you can take behavioral biases and work with them, as opposed to just assuming they’re the devil, and you always need to try and overcome them over time.

Fraser Jack
I’m glad, I’m glad you said that. Because that’s exactly where my mind went when you said that it’s kind of like a bias, but it’s also something that helps them understand and the whole idea of informed consent and understanding the information and be able to tell their friends at the barbecue as to why they’re doing those certain things. Thanks. Thank you for that. David, when we talk about the different the different areas around, you know, behavioral bias and investing, what are your thoughts?

David Bell
Well, it’s such a fascinating area. If you think about the academia of all this, you had sort of 50 6080 years of rational market theory and all the academic saying, Oh, the world’s rational, every decisions, informed decision and so forth. And then, really over the last 30 to 40 years, you’ve had a behavioural insights coming into the fray. And it’s sort of not that well known. But yeah, academic literature, in a way push back from publishing most of these areas for a long, long time. And now, it’s a really opened up for the last 1020 years, you’ve just seen a whole wave of research, which brings rational and behavioral decision making together and tries to explain a broader view of how decisions are made made. So it’s very fascinating. And you can see across so many different parts of the industry and the way decisions are made. So just to broaden it out a little bit, you can rein me back in Fraser, if you think about the way that saving systems are designed, so Superannuation is really a big notch, and it’s sort of compulsory saving. And if you left that choice to the individual, people would struggle to make that decision to save, you know, 10, put 10% of their savings aside. So that’s a giant nudge. And that’s sort of a common design, which accounts for behavioral bias in terms of savings behaviors, if I bring it back to the investment management world, it’s fascinating what you see in the institutional investment management world. So past Korea, I still work in the hedge fund world. And I’ve visited a number of funds, with amazing investors who have in house psychologists who sit, sit alongside a data expert, and they’ll actually be analyzing every trade by trade decision that their portfolio managers are making, to try and identify their particular behavioral biases. And some of the ones that Dan mentioned really come to the fore, and a couple here. So what you call disposition effects. And that is that people prefer to sell their when to sell their winners and how they lose it say, Yes, I’m sort of an endorphin rush from realizing your profit and you say I go home that day. So I’ve locked in some good profits here. I feel good about myself. And then you hold you lose is you don’t want to have to accept that you’ve made a loss on this position. And I’ve seen that I’ve seen amongst family decision making and you see it in the institutional world as well. And things Yeah, you do. And that’s why you have things like investment committees where someone comes in at the top and says, Look, you just have to get out of this position. You’re just denying the obvious say that this company’s just not going to recover and thesis a that type of thing at institutional levels. And then of course, it can step down to retail decision making and really bring it back to what Dan’s saying, is this amazing value add for advisors in terms of being able to work through some of these behavioral biases, perhaps give comfort to a client to work through them and put them aside but also this ability, nearly behavioral alpha, nearly at the advice level to turn some of them into a positive step that the clients can take,

Fraser Jack
you know, you mentioned in that the concept of behavioral decision making and, you know, logical decision making as two separate things, which I found was really interesting. Especially in the, you know, obviously, when we’re talking to clients in in consumer, it’s very obvious that a lot of decisions are made emotionally, or behavioral, or, as we’re going to call it. But yeah, it’s really interesting to hear that conversation around, you know, in the investment committees in the investment management space, and even in the hedge fund space, that the the behavioral stuff comes so much into it, because you just you make this assumption, I guess that all gonna be based on rational decision making. What are your thoughts, then?

Dan Miles
Yeah, no, it’s definitely not, in fact, what we mean, I don’t want this to turn into any kind of product flow. But we’ve set up our investment committee and our investment processes to be as largely systematic as possible to try and overcome what we recognize as behavioral biases that we, that we, we know will come to the fore. And just because you’re conscious of them doesn’t mean that you’re not going to necessarily, you know, react to them, or you’re, you’re going to be able to ignore them. And so having processes in place, to, you know, when you when you have lost makers, if the information has changed, and the the information you now have says that, you know, this, this your original assumptions, your original inputs that you use to make that decision are no longer valid, it has to go. And if you’ve got something that has done really well, and, you know, the immediate thought process, maybe we should, we should book some profits. But if the underlying investment thesis and the the forecasting methodology, assuming your use one is still sound, in fact, could be improving, that, you know, you’re in a position that you need to you need to can, you know, say in that, you know, some examples of these, you know, going into COVID Did towards the end of March, you know, we were, we were very, extremely nervous about what could determine if everybody thinks back to the end of March, I mean, no one had any idea what the pandemic could have meant, and the market had already fallen 30%. And, you know, it was, it was, it was a very difficult time when thinking about second waves and how they had what this could have in the economy and data. But we had processes in place that said, you have to buy like you have to like you just you have to reinvest, and we had divested prior to that, not because of the pandemic, but because of valuation issues. Those it was those, it was that systematic approach to overriding the human decision making, I kind of described it as a compass, you know, it tells us north, south east and west and, and then the human element can come in and say, Well, maybe you want to take a boat to get to this place, instead of applying or, you know, depending on the weather, or you might want to go, you know, North by North East instead of, you know, just directly north, but at the end of the day, you still need that compass. Otherwise, your own human biases, your own emotions are going to have a huge effect over the portfolio decision making and generally in a very destructive fashion, unless you get lucky. And you know, sometimes people do get lucky and then they claim it just skill. I think

Fraser Jack
that past has shown us that there’s been a huge amount of luck over over the past and people benefiting from it and making them putting their hand up and saying how great they’ve done. I wanted to quickly touch on the the anchoring conversation too, because I think it’s a really important one, obviously, you know, the obvious is anchoring to past performance. And a very easy one for people to look at or nor past fees or whatever it might be. And you know, there’s plenty of benchmarks to anchor against talk to us about anchor might get you just saw this one time.

David Bell
Yeah. If I just jump back to what you’re going through there. That was fascinating, Dan, and I guess what you’re pointing to is some systematic rules, which are largely based on fundamentals and it’s also quite common to see system make rules based on p&l Say, yeah, he turns like the classic stop loss. It’s really a behavioral control to stop people and pull them back in and say Your p&l has reached a certain level you have to go in and have a good thing about this now so yeah, these things are everywhere. Yeah, anchoring is a very common one as well. Yeah, fascinating. Little subtopic and in Australia, DC anchoring on past performance is one of the bigger issues. phases one, but even portfolio ages and selves, they have a set of principles and maybe even favorite companies, Missy examples of anchoring around CEOs that people quite like say you’ll sort of see a whole range of just little rules of thumbs, you may not even know them yourself. And that’s, that’s the value of having this people communicate when you check out what you’re doing, or a good investment committee who are truly independent and just come from different perspectives. To just challenge you a little bit, keep it fresh, and make sure that you’re wading through some of these barriers.

Fraser Jack
Yep. Then what are your thoughts around anchoring? Because I actually have this idea of anchoring. That can actually mean, you’ve got experience.

Dan Miles
Yeah, as I was saying, anchoring and your point about it can mean experience, it absolutely can it can mean experience. And if that experience allows you to make better decisions in the future, then it can, it can be a good thing, but quite often, you can be anchored to a historical experience that is completely spurious when viewed in a future context, because it may have no relevance whatsoever as to what could occur into the future. You know, we’ve had 40 years of, you know, the Great Moderation. If people anchor to that and assume that the next 40 years, we’re going to continue to have decreasing rates and increasing multiples, you know, there’s a very high probability that the the result in their portfolio could be could be fairly, fairly mediocre. But from an advisors perspective, recognizing that clients will come in, and they will have previous experience, and they will have things that they that they anchor to, and that they have their favorites, because they may have worked, it worked for them in the past, being able to be armed with knowledge to be able to explain to them why it may have worked in the past, and why why it may or may not work in the future, can help with those conversations. Because you know, quite frequently people will look at property, for example, and say, you know, I would did extremely well on property and property was fantastic. But if you 30 years ago, instead of buying a house, in a major city you bought you were able to buy a 30 year Australian government bond, which you couldn’t, and held it to maturity, you would have you would have done that the majority there is the results that have come from the property market have been the fact that you’ve been able to leverage the living hell out of it over that period of time, it hasn’t actually been because it’s been a fantastic investment. And so anchoring to that previous thing can can prevent the client from potentially taking on less, less risks that they should not be taking on or don’t need to take on to achieve their goals. But if you can go into the conversation, recognizing that they have these biases in place, you can at least have an informed conversation instead of flying blind is my belief.

Fraser Jack
Very good. Now, I wanted to bring up the conversation around another sort of bias that a lot of clients start with. And that is, you know, the the now wanting things now the short term ism, I think you call that earlier down. What are your thoughts on this, this behavioral bias around? You know, wanting things now and only being able to think about now and striking thing about the future?

David Bell
Yeah, the myopic view that people have, and it’s true. And that’s why that’s why saving systems exist, we’ve compulsory savings because people can’t defer present enjoyment for future outcome. So that’s a that’s a very common one. And yeah, a good example is a saving system design I just mentioned, but it’s very practical example sound the best behavioral experiments have been pre order your lunch for weeks time, your your order a salad in a week’s time that if you’re there on the day ordering your pick the hamburger, and yeah, that’s a very common as well. So there’s all these examples, not just in finance, but all around every day activities. You know, the way you defer exercise, you’ll pick it in, I’ll go for that jog, tomorrow, everything like that. Everything is all about present enjoyment. And so this is actually estimates of the factor, the time distance, disposition effect of all the things that you can factor into your models when you’re designing portfolios, and so forth. And yeah, that’s that’s getting a pretty interesting areas is as you’re designing systems, so yeah, like, regulators and policymakers, it’s all pretty tricky. Should they allow for this or not? And probably my,

Dan Miles
it gets very exciting when you when you talk about the tech space and some of the modeling that is coming out that has been made available to advisors, where previously they’ve had to use linear models where, you know, they’ll draw a chart up on a board and say, This is what will happen on average, but the only thing I can tell you is that I know this is not what’s going to happen. I mean, if there could be more useless conversation in the entire world. Ice industry, I have no idea what it is. But you know, another form of short term ism is, you know, academically known as hyperbolic time anchoring, which is exactly what David was talking about his, his people don’t like to put off things for tomorrow to deal with them today. But there are certain technological solutions that advisors can get access to that can help people to visualize what it actually means to put things off today, and what that will actually generally mean for them in the future, to try to have a behavioural visceral response, which may lead to a more positive behavior, which is, which is this whole idea of going into the conversation, being aware of the behavioral biases, and having some tools to be able to do it, so they don’t have to necessarily be a negative thing, you can turn them into a positive thing?

David Bell
Yeah, that’s great. So the best examples I’ve seen of that dance around technology based solutions, where to try and encourage encouraging people to save more is such a hard thing to do. And so one technique I saw in an academic piece, where they teamed up with some clever technology people was to take a photo of you as a starting point. And then when you’re making that decision, they had created an aged photo of yourself, so you could picture as your future self. And that actually led to people saying, I’m going to save more, because I could picture myself in that situation more. Another interesting piece was when a couple of academics teamed up, I think it was a project with Microsoft or something where they tracked your savings behavior, and projected by looking up the classifieds for rental properties, what house you’re going to live in at the age of 65. And they said, Yep, if you tick this box on your savings rates, this is what your apartments going to look like. And if you take the alternative, right, you’re going to be in a pretty crappy apartment. And that sort of could really translate the present into the future and says, connections, which you can see how important it is for advisors to be able to do that imagery and create that setting. And that’s really the framing piece, which is crucial to breaking down some of the behavioral biases.

Fraser Jack
Yeah, I think that imagery is really important. I think a lot of advisors and planners do that very well. Now, bringing, bringing clients back, you know, from the future mention projecting into the future, bringing clients back from the future to now and trying things on, you know, the older, you’ve just woken up in the morning, are you having WeetBix? Are you having a cooked breakfast? You know, that’s the, the, the options you have right now, but obviously, you’re talking about the future of those things. So a lot to digest there. Now, probably just one of the other things I wanted to touch base on this was around some of the different personalities. And obviously, you know, there’s bias in couples, when we, when you when you when people are dealing with clients is there’s often an alpha personality or non alpha or, you know, the CFO or the non CFO in the conversation. How do you manage to what are your thoughts down around bringing both those personalities into the conversation, making sure that there’s no bias been one over the other?

Dan Miles
I’m not sure I’m not as qualified to answer, I think I can provide suggestions that I’ve gotten from some advisors that I believe do it quite well, in that they, they have the meeting with the couples, but then also have the meetings with the the partners in the the arrangement, but have them individually, then bring them back and show the difference between the two, because when they’re alone, they’re far more likely to be able to express their personal opinion and without having to worry about what the other person thinks. And I think that practice from from, you know, just from my own personal experiences, just logically seems like it’s a very, very sensible way about going about doing it because it is is going to be very frequent. We know it is very frequent. In relationships, you know, it doesn’t have to be the the male is the alpha could be the females matter, the average could be the one male with another, like, it kinda doesn’t matter. There’s, there’s someone who frequently defers to the other, but they may have certain fears and concerns about what’s going on. And they’re not they don’t feel comfortable enough expressing them, separating them and allowing them to speak freely in a controlled environment. So that then it can be brought back and you know, they can meet face. Normally the alpha type personality will generally the Oh, okay. All right. Well, if that’s how you feel, you know, we’re in a, we’re in a partnership of some, you know, sort whether it’s a business partnership or a relationship or whatever the case may be, we kind of need to meet somewhere where we’re both happy. And I think that is a it’s a it’s a very simple but very effective way of approaching it

David Bell
is. I’m glad you raised the question. It’s a really important one. It’s something I was pondering on just as I was thinking about these podcasts and if I just lived up to a high level just to set my scene a little bit which is just first of all that rational piece and risk aversion is really where it’s at. And that’s the most common framing of language. But it’s also is this sort of other area that I think is important, which is what you call ambiguity aversion. And that is, you sort of have some sort of risk appetite. But you’re prepared to take risks that you don’t really understand. So you might know the stats that sit around, jumping out of a plane with a parachute, but there might be other sort of risk areas where you don’t actually understand the odds. And that may actually say, Well, geez, I’m not prepared to take that risk, because I don’t really understand it. And if you apply that back to finance, well, financial literacy levels are really low, and say, teasing out the two, you might actually have some sort of risk aversion around financial decision making, it actually may not, they may not be risk averse at all, they may or may not understand finance at all. And hence, it’s quite rational not to want to take risks there. So there’s sort of a little bit to unpack there. And, and this gets you back to that sort of household structure, which is really important, what Dan was saying, I sort of agree with him there. If I just apply that framing to the to the alpha personality, you think about the Alpha characteristics, their laid, self assured, powerful, sort of confident in everything they do. But that’s also where the risk is, because what happens if their financial literacy levels are that great, then they sort of feel like they have to make a confident, strong decision. Yet? They don’t, they’re not really set up to do that well, and say, there’s actually an alarm bell there for an advisor, if they identify that sort of alpha characteristic. They really have to filter that. What do these people understand about financial decision making in general otherwise, you get a strong response, put a plan together, I think you’re doing everything well. And you may not turn out good at all. And so it’s really interesting area.

Fraser Jack
Yeah, there are very so many very interesting areas around this. Gentleman, thank you so much for joining me in this particular episode. We look forward to jumping back into the conversation with you guys when we tackle goals based investing in the next episode. Thanks, guys.

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