Your Brain Is Stealing $245,000 From Your Retirement (Here's How to Stop It)

Speaker 1 Our brains, magnificent as they are at things like recognizing faces and remembering song lyrics from 1987, were designed by evolution to keep us alive in the jungle, not to optimize our Roth IRAs.

Speaker 1 We're running Savannah software on stock market hardware, and it's causing spectacular, expensive errors that would be hilarious if they weren't happening to our actual money.

Speaker 1 Hello friends, this is Tyler Gardner welcoming you to another episode of Your Money Guide on the Side, where it is my job to simplify what seems complex, add nuance to what seems simple, and learn from and alongside some of the brightest minds in money, finance, and investing.

Speaker 1 So let's get started and get you one step closer to where you need to be.

Speaker 1 Welcome back to Your Money Guide on the Side, the podcast where we attempt to make your money work harder so you don't have to, or at least so you can worry about it less while you're working hard at other things, like pretending to pay attention during Zoom meetings or finally learning to make sourdough, which, let's be honest, you're never going to do, but I appreciate that we all have our mental endeavors nonetheless.

Speaker 1 I am thrilled you're still here, genuinely. What I mean by still is we're now at year's end.
We've almost made it through an entire year of this podcast journey or endeavor.

Speaker 1 So as always, before we jump in, A, thank you. B, I have a small favor to ask, which I promise is less awkward than asking you to borrow money.

Speaker 1 If this podcast has helped you, maybe prevented you from panic selling during a market dip, helped you understand why index funds aren't actually boring but brilliant, or both, or simply made you feel less alone in your financial confusion, please consider leaving a review on Apple Podcasts or wherever you're listening.

Speaker 1 Reviews genuinely help other people discover the show, and they help justify to my spouse that talking into a microphone alone in a room is a real job and not just an elaborate scheme to avoid household chores.

Speaker 1 That's just an added benefit. Quick prenote to this episode.
This is one of my longer solo episodes as there's so much info to unpack here.

Speaker 1 So I give you full permission and approval to listen to me on 2x starting now.

Speaker 1 Today's episode is the first of yet another two-part series, Mia Culpa, when I start writing, I really do start writing, and I'm genuinely excited about this one.

Speaker 1 As many of you have been asking me to cover this topic in depth, we're going to tackle behavioral economics, specifically the psychological quirks and mental shortcuts that are systematically destroying your investment returns.

Speaker 1 In this first episode, we'll cover five biases that you may have heard of, but probably haven't fully appreciated for the portfolio damage they're causing. Think of these as like the greatest hits.

Speaker 1 These are the ones that get name-dropped at dinner parties by people who read one Malcolm Gladwell book and now consider themselves experts on human behavior.

Speaker 1 I've mentioned many of these behaviors before as subplots in other episodes, but this week and next, I'm finally allowing them to take center stage.

Speaker 1 And next week in part two, we'll dig into the deeper cuts. The behavioral biases that are equally destructive, but don't get nearly as much airtime.
Consider this your behavioral economics world tour.

Speaker 1 This week is Madison Square Garden and Wembley Stadium, the venues everyone knows.

Speaker 1 Next week is the underground clubs and genuine speakeasies where the real magic, or in this case financial carnage, actually happens.

Speaker 1 So let me start this week's episode with some data that should make you deeply uncomfortable, because if it doesn't, you're either not paying attention or you've achieved a level of enlightenment I can only hope to aspire to.

Speaker 1 According to Dalbar's quantitative analysis of investor behavior, which has been documenting our collective financial self-sabotage for over 30 years, like a very patient therapist who's given up hope will ever change, the average equity investor has consistently, almost heroically, underperformed the stock market itself.

Speaker 1 Over the 20-year period ending in 2022, the S ⁇ P returned approximately 9.8% annually in nominal terms, aka pre-inflation adjustment. The average equity investor, just 6.8%.

Speaker 1 That's a 3 percentage point annual gap, which might not sound dramatic until you do the math. At which point, you're going to need to sit down.

Speaker 1 Because on a $100,000 investment over 20 years, that difference is almost a quarter of a million dollars. That's not a rounding error.
That's a house in many markets.

Speaker 1 Well, at least it was during our parents' generation. Or four years of private college tuition.
Again, maybe not today, based on what I just saw Wellesley's charging for next year.

Speaker 1 Or 61,250 artisanal lattes, or approximately 12,250 avocado toasts, depending on how you prefer to measure financial regret and whether you live in a city where that toast costs 20 bucks.

Speaker 1 And here's what makes this particularly painful. like watching yourself trip in a video on repeat.

Speaker 1 This performance gap isn't because people are invested in terrible high-fee funds managed by someone's incompetent nephew who took one finance class in college and decided he had a gift for this.

Speaker 1 No, this gap persists even when investors hold perfectly reasonable, low-cost index funds.

Speaker 1 So even if you've taken the steps that I've tried to outline over the past few years in the content and you hold low-cost, tax-efficient funds, That's only half the battle.

Speaker 1 The problem isn't the investments. The problem is the investor.
The problem is us.

Speaker 1 I'm including myself here because I've absolutely made these mistakes and claiming immunity would be both dishonest and a perfect example of the first bias we're about to discuss.

Speaker 1 Our brains, magnificent as they are at things like recognizing faces and remembering song lyrics from 1987, were designed by evolution to keep us alive in the jungle, not to optimize our Roth IRAs.

Speaker 1 We're running Savannah software on stock market hardware, and it's causing spectacular, expensive errors that would be hilarious if they weren't happening to our actual money.

Speaker 1 Now, here's the quick history, aka what you actually need to know about the academic research that's led to where we are.

Speaker 1 For most of economic history, Economists made a generous, borderline, charitable assumption that humans are rational actors who make logical, self-interested decisions based on available information.

Speaker 1 And man, did we love this theory. This was called rational choice theory, and it was elegant, mathematically beautiful.
It won Nobel Prizes. But it had one tiny and significant flaw.

Speaker 1 It was completely, spectacularly, wrong.

Speaker 1 Because then in the 1970s, two Israeli psychologists named Daniel Kahneman and Amos Versky started doing something revolutionary and slightly subversive.

Speaker 1 They actually asked people questions and watched what they did, rather than just theorizing about what perfectly rational beings would do in some imaginary universe.

Speaker 1 They discovered that humans aren't just occasionally irrational when we're tired or hungry. We're predictably, systematically, reliably irrational.

Speaker 1 We make the same mistakes over and over again, like a sitcom character who somehow never learns that lying always

Speaker 1 things worse.

Speaker 1 Kahneman and Versky documented dozens of cognitive biases, mental shortcuts, and systematic errors in thinking that affect our decisions.

Speaker 1 Kahneman won the Nobel Prize in Economics for his work in 2002. Versky would have surely shared it, but he'd passed away in 1996, and the Nobel isn't awarded post-humously, unfortunately.

Speaker 1 Richard Thaler then built on their foundation, specifically applying these insights to economic decisions.

Speaker 1 He documented documented how real humans save, spend, and invest, which is to say, poorly, but very consistently, like we're all following the same terrible instruction manual.

Speaker 1 He also won the Nobel Prize in Economics in 2017, making behavioral economics the most Nobel-heavy field in economics, which is either impressive or a damning indictment of how wrong traditional economics was.

Speaker 1 I'm going to go with both. The field has exploded since then, giving us a really rich vocabulary for describing our financial foolishness.

Speaker 1 Anchoring, framing effects, loss aversion, herd behavior, the sunk cost fallacy.

Speaker 1 These concepts have become part of the cultural conversation, showing up in TED Talks and business books and that one friend who reads too much and won't stop explaining why you're wrong about everything.

Speaker 1 But here's the thing. Knowing about these biases and actually avoiding them are two entirely different things.

Speaker 1 Like knowing that eating an entire pizza isn't healthy versus actually not eating an entire pizza.

Speaker 1 The knowledge doesn't make the pizza less appealing, and it certainly doesn't make your brain suddenly start making rational decisions.

Speaker 1 If anything, it just makes you feel worse about your choices, which is somehow even less helpful.

Speaker 1 So let's dive into five of the most common, most destructive behavioral biases affecting your portfolio. You've probably heard of some of these, but I'm willing to bet you're still committing them.

Speaker 1 I certainly am, which is why I've had to build systematic defenses against my own brain, like a financial immune system protecting me from, well, myself.

Speaker 1 And again, next week we'll dive into the 2.0 version with five that maybe you have not heard as much about.

Speaker 1 Look, I spend a lot of time on this podcast talking about retirement planning, investing, how to build wealth without getting ripped off by fees.

Speaker 1 And I love doing it, genuinely, because here's the thing. I get hundreds of of emails every week from listeners like you asking me to address their specific situations.
Should I do a Roth conversion?

Speaker 1 How much should I have in bonds at 53?

Speaker 1 I have 200K in a 401k and 80K in a brokerage. What should I invest in? And I want to help.
I really do. But I cannot give you personalized advice.
I can educate. I can speak generally.

Speaker 1 I can tell you what I might do. But your net worth, your retirement timeline, your tax situation, your life.
It's way more nuanced than anything I can responsibly address to a general audience.

Speaker 1 That's why I continue to love working with Facet. They're a team of actual CFP professionals who can look at your specific scenario and build a plan that actually fits you.

Speaker 1 not some one-size-fits-all template, not a sales pitch for high-fee mutual funds, just real financial planning from people who know what they're doing and who charge flat annual membership fees, not a percentage of your assets.

Speaker 1 So if you've ever thought about writing me an email asking what you should do, don't, because I simply can't answer that. But Facet can.

Speaker 1 So go to facet.com slash Tyler and talk to someone who can actually help. That's factet.com/slash Tyler, because you deserve a plan that's built for you.
Facet is an SEC registered investment advisor.

Speaker 1 This is not advice. All opinions are my own and not a guarantee of a similar outcome.
I'm not a member of FACET.

Speaker 1 I have an incentive to endorse FACET as I have an ongoing fee-based contract for cash compensation, as well as a percentage of equity in Facet based on this endorsement.

Speaker 1 Bias number one: overconfidence bias, or why we're all above average. Overconfidence bias is the tendency to overestimate our own abilities, knowledge, and predictions.

Speaker 1 It's why over 90% of American drivers consider themselves above average, which is mathematically impossible unless we're grading on a very generous curve that I apparently wasn't informed about.

Speaker 1 It's also why 94% of college professors believe they're better at their job than their colleagues, which suggests that academia is either full of geniuses or a delusion, and having spent much of my life in academia, I have my suspicions.

Speaker 1 And it's why you think you can pick winning stocks despite all evidence to the contrary, including your own dang track record, which you've conveniently forgotten because remembering our failures is uncomfortable.

Speaker 1 In investing, overconfidence manifests in several spectacular ways.

Speaker 1 First, there's the illusion of knowledge, the belief that because you've read some articles, listened to some podcasts, including this one, which definitely doesn't make you qualified to day trade, or watched CNBC while eating breakfast, you now have insights that professional analysts with teams of researchers in Bloomberg Terminals somehow missed.

Speaker 1 This is like thinking you can perform surgery because you watched a season of Gray's Anatomy, or that you understand of quantum physics because you saw Oppenheimer. You don't, and you shouldn't try.

Speaker 1 And the only thing you should ever take from Gray's Anatomy is that the show would have been light years better if Danny Duquette had simply exited stage left and not returned in the form of a ghost season after season after season?

Speaker 1 Brad Barber and Terence O'Dean did landmark research on overconfidence in investing, analyzing thousands of brokerage accounts over several years.

Speaker 1 They found that the investors who traded most frequently, I bet you know where I'm going with this, presumably because they believed they had superior insight, like some kind of financial Nostradamus, underperformed the market by about 6.5% annually after costs.

Speaker 1 Meanwhile, the investors who traded least frequently, possibly because they were wise or because they were just lazy. Doesn't matter.
They nearly matched market returns.

Speaker 1 The overconfident investors weren't just wrong. They were expensively, demonstrably, embarrassingly wrong.

Speaker 1 Men, and I can say this as a card-carrying member, someone who has personally committed this error, are spectacularly, particularly susceptible to overconfidence bias when it comes to investing and anything else.

Speaker 1 The same research showed that men trade 45% more than women, and this excess trading reduces their returns by 2.65% per year compared to women's 1.72% reduction from overtrading.

Speaker 1 Overconfidence literally costs men about a percentage point in annual returns.

Speaker 1 So, gentlemen, if anyone asks why women should manage the investment portfolio, you can cite peer-reviewed academic research showing they're statistically better at not screwing the old metaphorical pooch.

Speaker 1 You're welcome for that conversation starter, and please let me know how that one goes.

Speaker 1 Overconfidence also leads to under-diversification, because if you're certain you know which stocks will outperform, why diversify? Why own anything else? Just load up on your winners and get rich.

Speaker 1 Like when I offer short-form videos about proper diversification across asset classes, and some ding-a-ling without fail says in the comments, just buy Nvidia and hold it for life.

Speaker 1 Okay, dude, I got the same comment via fax in the late 80s about Enron, Kodak, and Blockbuster, but hey, you do you.

Speaker 1 The long-term problem, of course, is that you don't know which stocks will outperform. No one does consistently.

Speaker 1 Not even the professionals who went to Wharton and wear expensive suits and talk confidently on television. See, Kathy Wood.
This is why you see portfolios concentrated in five stocks or one sector.

Speaker 1 Someone was very confident and very wrong. And now they're explaining to their spouse why retirement might need to be delayed just a few more years and don't worry, it's cool to keep working.

Speaker 1 The fix for overconfidence is uncomfortable. Like most useful truths, intellectual humility.
Except that you probably don't have an edge. If beating the market were easy, everyone would do it.

Speaker 1 And if everyone did it, it would be impossible. It's a logical paradox, wrapped in a humility lesson, wrapped in the reason index funds exist.

Speaker 1 So instead of trying to pick winners, own everything through low-cost index funds, you'll capture market returns, which historically is pretty darn good, about 7% annually over the long-term post-inflation, which is more than enough to reach most financial goals.

Speaker 1 As Vanguard founder Jack Bogle said, don't look for the needle in the haystack. Just buy the haystack.

Speaker 1 This is possibly the wisest investment advice ever given, and it has the advantage of being boring enough that you won't be tempted to check it daily.

Speaker 1 Also, for the overconfident men out there, try tracking your predictions over five years, or even just one year.

Speaker 1 Write down what you think will happen in your little investment journal, you know you have one, and check back in a year, and then in five years.

Speaker 1 Most people who do this discover they're essentially flipping coins, which is humbling and useful and might save you from making large bets on your hunches and if you must trade individual stocks because you find it intellectually stimulating or because you like the thrill as i've said before and will say forever limit it to a small entertainment portion of your portfolio say five percent that way when you're wrong and statistics say you're going to be wrong it's educational rather than catastrophic think of it as tuition for the school of hard knocks but with a reasonable tuition cap.

Speaker 1 Bias number two, recency bias, the belief that whatever just happened is definitely going to keep happening.

Speaker 1 Recency bias is the tendency to overweight recent events and assume current trends will continue indefinitely into the future, defying both logic and, you know, history.

Speaker 1 It's why people buy flood insurance right after a flood, but not before. Why the last movie you saw seems like the best movie ever until you see another one next week.

Speaker 1 And why when I studied at London School of Economics, every time I read an article for homework, I was like, yep, this guy's right.

Speaker 1 Until I read the following night's assignment that argued the counter and I was like, yep, this person's right. Note, I got a lot of C's on my ultimate transcript over there.

Speaker 1 This is also why investors pile into whatever did well last year, convinced the party will continue forever, or at least through next quarter.

Speaker 1 And it's why whenever you claim you've researched the funds you're in, you just mean you've looked at the last few years of performance and said, yep, these look good.

Speaker 1 In investing, recency bias is devastating, like bringing a knife to a gunfight, except you brought the knife to your own financial future.

Speaker 1 After years of strong stock market returns, investors become convinced that stocks only go up, that we've entered some new paradigm where it downturns our historical curiosities, and they pour money in at precisely the wrong time, time, right before the crash.

Speaker 1 After a market crash, they become convinced stocks are permanently dangerous, that we've entered a new era of perpetual decline, and they flee to cash, missing the recovery entirely.

Speaker 1 It's like dating someone terrible because your last relationship was great, or avoiding relationships entirely because your last one was terrible.

Speaker 1 You're letting one recent data point overwhelm all other evidence, which should be obvious, is a terrible way to make any decision. Perfect example was the dot-com bubble of the late 1990s.

Speaker 1 Technology stocks had been soaring for years, returning 20%, 30%, sometimes 50% annually. And investors became convinced that the old rules somehow just didn't apply.

Speaker 1 This was a new economy, a new paradigm, and you simply had to be in tech or you were a fool missing the opportunity of a lifetime. Sound familiar?

Speaker 1 Companies with no profits and no realistic path to profits were valued in the billions because, well, internet.

Speaker 1 Then, shockingly, to no one except the people who lost tons of money, the old rules did apply. Gravity reasserted itself, reality returned with a vengeance, and the NASDAQ dropped about 78%

Speaker 1 from peak to trough between 2000 and 2002.

Speaker 1 Investors who had piled in based on a recent performance got absolutely annihilated, which is a polite way of saying they lost several years of retirement savings. Or consider 2008 and its aftermath.

Speaker 1 After the financial crisis when banks were failing and the world seemed to be ending and everyone was wondering if capitalism itself was broken, again, sound familiar, investors fled stocks in droves.

Speaker 1 Equity mutual funds saw massive outflows in 09 and 2010, years when the market was recovering strongly. posted gains of 26% and 15% respectively.

Speaker 1 These investors, traumatized by recent events and convinced the bear market would continue indefinitely, missed out on incredible gains because recency bias convinced them that what just happened would keep happening, despite literally all of market history suggesting otherwise.

Speaker 1 The psychological mechanism is simple, almost embarrassingly so. Recent events are vivid and easily recalled, so our brains overweight them when making decisions.

Speaker 1 It's a useful shortcut in many contexts. If you touched a hot stove yesterday, it's smart to be cautious around stoves today.
If a bear chased you last week, it's wise to avoid that area.

Speaker 1 But markets aren't stoves or bears. They're complex, adaptive systems where recent performance is nearly useless, possibly even negatively correlated for predicting future performance.

Speaker 1 In fact, there's often a negative correlation between recent performance and future returns.

Speaker 1 Assets that have done well recently tend to be expensive, potentially overvalued, and have lower forward returns.

Speaker 1 Whereas assets that have done poorly tend to be cheap, relatively undervalued, and have higher forward returns. But recency bias makes us do the exact opposite of what we should.

Speaker 1 We chase performance, buying high, selling low, which is the investment equivalent of running toward a tornado because the sun was shining five minutes ago. Here's an antidote.

Speaker 1 Look at long-term data and understand historical patterns beyond what happened last week or last quarter.

Speaker 1 Yes, stocks crashed in 08, losing about 37% that year, but they've also recovered from every single crash in history, 1929, 1987, 2000, 2008, COVID, every single one.

Speaker 1 But the average intra-year decline in the S ⁇ P 500 is about 14%,

Speaker 1 even in years that end positive. So volatility isn't the exception.
It's the price of admission, the cost of doing business, the thing you sign up for in exchange for long-term returns.

Speaker 1 Also, avoid performance chasing like you'd avoid food poisoning from that roast beef that has been in the fridge for one day too long.

Speaker 1 If you find yourself wanting to invest in something because it's up 50% this year, that's recency bias talking. And you should probably do the opposite.

Speaker 1 Create an investment policy statement when you're calm and rational, not after the market has moved dramatically in either direction. And stick to it, regardless of recent events.

Speaker 1 Your calm, rational self sitting there on a Sunday afternoon with a cup of coffee is much smarter than your panicked or euphoric self watching the market move in real time.

Speaker 1 Bias number three: endowment effect. Why we overvalue what we already own, even when we shouldn't.
The endowment effect is the tendency to overvalue things simply because we own them.

Speaker 1 As if ownership itself confers magical value-adding properties. It's why you think your used car is worth more than an identical car on the dealer's lot.

Speaker 1 Why you're convinced your house should sell for more than comparable homes in your neighborhood, but we updated the bathroom last year.

Speaker 1 And why you hold on to investments that you'd never ever buy today at current prices if you were starting fresh.

Speaker 1 This was brilliantly demonstrated by Richard Thaler in a series of experiments involving coffee mugs, which sounds boring, but is actually quite revealing about human nature.

Speaker 1 He gave half the participants mugs and asked them what price they'd sell them for. He asked the other half what they'd pay to buy an identical mug.

Speaker 1 Economically, these prices should have at least been similar. A mug is a mug is a mug, no matter who's holding it.

Speaker 1 But the sellers demanded about twice as much as the buyers were willing to pay for a mug.

Speaker 1 Simply owning the mug made it seem more valuable, as if ownership bestowed special properties the mug didn't actually have.

Speaker 1 In investing, this endowment effect causes people to hold stocks they inherited or bought long ago, even when those stocks no longer fit their investment strategy, risk tolerance, or financial goals.

Speaker 1 I've seen portfolios with enormous positions in a single company stock, often an employer's stock or something inherited from a relative, that the investor would never choose to buy today, but can't bring themselves to sell because it's been in the family, or it's been good to me, or dad would have wanted me to keep it, as if the stock itself has sentimental value, which it doesn't because it's literally just a financial instrument.

Speaker 1 What dad would have have really wanted was for you to learn about endowment bias. Here's a useful thought experiment that will make you uncomfortable.

Speaker 1 If you had cash instead of this investment, would you buy that investment today at current prices in the amounts that you have?

Speaker 1 If the answer is no, you wouldn't buy it fresh, you probably shouldn't own it.

Speaker 1 The fact that you already own it is emotionally relevant, but financially meaningless, like being emotionally attached to a parking spot.

Speaker 1 Your portfolio doesn't care about the narrative you've you've attached to each holding, the story of how you bought it or who gave it to you.

Speaker 1 It only cares about whether these holdings are appropriate for your goals.

Speaker 1 The endowment effect is particularly dangerous with individual stocks, where people develop emotional attachments that would be touching if they weren't so expensive.

Speaker 1 This was their first stock purchase, a milestone. Or it's their employer's stock.
and they feel loyal.

Speaker 1 Or it's Apple and man do they love their iPhone and can't imagine selling the stock of a company whose products they use daily.

Speaker 1 But your iPhone's quality has absolutely no bearing on whether Apple stock is appropriately valued for your portfolio at this moment.

Speaker 1 These are separate questions, like whether you should marry someone because you like their cooking. Sure, it's related, but it's not sufficient.

Speaker 1 The effect is amplified by loss aversion, which we'll discuss in a moment.

Speaker 1 If you're sitting on a loss, the endowment effect makes you reluctant to sell because you'd be giving up on something you own, something that's special, admitting defeat.

Speaker 1 If you're sitting on a gain, you might be reluctant to sell because you'd be giving up this winner, this thing that's working and again, emotionally attached to you.

Speaker 1 Either way, ownership creates an irrational attachment that will and does cloud your judgment. Fighting the endowment effect requires ruthless objectivity, which is harder than it sounds.

Speaker 1 Regularly audit your portfolio, at least annually, and ask if I were building this portfolio from scratch today with fresh cash, would I choose these exact investments in these exact amounts?

Speaker 1 If not, you have endowment effect problems and you need to make some changes. Also, reframe selling not as losing something you own, but as choosing what you want to own going forward.

Speaker 1 You're not giving up a stock. You're actively selecting your portfolio composition, making an affirmative choice about your financial future.

Speaker 1 And this is where I will note, just because you have accumulated cap gains and you're going to take a tax hit, someday, somewhere, somehow, the goal was to sell this thing anyway.

Speaker 1 So don't ever let the potential tax hit stop you from doing what's right for your current and future optimal portfolio allocation strategy. Ever.

Speaker 1 And finally, please, please diversify concentrated positions.

Speaker 1 Even if you love the company, even if you work there, even if your grandmother founded the dang thing, I don't care if you work for Apple, Google, Microsoft, or whatever company makes you feel warm and fuzzy inside and gives you all the ping pong and free kombucha you could stomach, having a huge chunk of your net worth in one stock is imprudent, full stop.

Speaker 1 The stock could crater for reasons having nothing to do with product quality or company culture. Companies you love can be terrible investments.

Speaker 1 And companies that make products you dislike can be fantastic investments. Keep these separate like church and state or your professional life and your personal drama.

Speaker 1 Bias number four, loss aversion, why losses hurt way more than gains feel good.

Speaker 1 Loss aversion is one of the most powerful and destructive behavioral biases in investing and possibly in life generally.

Speaker 1 It's the tendency to feel the pain of losses much more intensely than the pleasure of equivalent gains. Research shows that losses losses hurt about twice as much as gains feel good.

Speaker 1 If you lose 100 bucks, the psychological pain is roughly equivalent to the pleasure of gaining $200.

Speaker 1 This is a terrible exchange rate for happiness. This also isn't a character flaw or a moral failing.
It's how our brains are wired. Courtesy of evolution.

Speaker 1 From an evolutionary perspective, it makes perfect sense. Missing out on a gain, not finding extra food, is unfortunate, but survivable.

Speaker 1 Experiencing a loss, losing your food to a predator, or being kicked out of your tribe could be fatal.

Speaker 1 Our ancestors who were more sensitive to losses, who really, really didn't want to lose what they had, survived to become our ancestors.

Speaker 1 The ones who were cavalier about losses became someone else's lunch. The problem is that this mental wiring, useful for survival on the savanna, is absolutely terrible for investing in modern markets.

Speaker 1 because loss aversion causes several destructive behaviors that would be comical, again, if they weren't hurting our own retirement accounts.

Speaker 1 First, it makes us way too conservative, keeping too much money in cash or bonds because we can't stomach the volatility of stocks, even though stocks have substantially higher long-term returns.

Speaker 1 We're so focused on avoiding short-term losses, the pain of seeing our account balances drop, that we sometimes guarantee ourselves long-term underperformance, missing out on decades of growth.

Speaker 1 It's like refusing to leave your house because you might stub your toe, thereby missing out on, you know,

Speaker 1 life.

Speaker 1 Second, loss aversion leads to spectacularly poor timing decisions.

Speaker 1 When the market drops 10%, the pain is so acute, so immediate, and so visceral, the stomach drops, you can't sleep, you check your portfolio compulsively.

Speaker 1 When the market's up 10%, the pleasure's mild, easily forgotten, already incorporated into our expectations. This asymmet

Speaker 1 sell during downturns when losses feel unbearable and underreact to gains, which feel less significant.

Speaker 1 You get the timing exactly backward, selling low, buying high, which is the opposite of the entire point.

Speaker 1 Third, loss aversion makes it incredibly difficult to sell losing investments, a phenomenon so common it has multiple names. Get evenitis, breaking even bias, or trying to get back to even.

Speaker 1 Realizing a loss, selling something for less than you paid, feels like admitting failure, like a personal defeat rather than a financial decision.

Speaker 1 So people hold losing investments way too long, hoping they'll come back, praying for a miracle while their money is locked up in declining assets.

Speaker 1 Meanwhile, they sell winners quickly to lock in gains, leading to portfolios full of losers and no winners, which is exactly the opposite of what you want. There's also myopic loss aversion.

Speaker 1 Myopic meaning short-sighted.

Speaker 1 Not that you need glasses, which is the tendency to evaluate your portfolio too frequently, which leads to seeing more losses because short-term volatility means lots of red days, which triggers loss aversion, which leads to overly conservative decisions.

Speaker 1 It's a vicious cycle of anxiety and underperformance. If you check your portfolio daily, you'll see losses about 46%

Speaker 1 of the time because the market is down roughly that often on any given day.

Speaker 1 If you check annually, you'll see losses only about 25% of the time because the market is up about 75% of the time over the course of a year.

Speaker 1 So the less frequently you look, the less your loss aversion is triggered, which is why ignorance is sometimes bliss and frequently profitable.

Speaker 1 Combating loss aversion requires reframing your mental models, which sounds like therapy speak because it basically is. First, understand that volatility isn't risk.

Speaker 1 It's the price you pay for long-term returns. Markets go up and down.
That's not a bug, it's a feature, it's how the machine works. The risk isn't temporary declines.

Speaker 1 It's not meeting your long-term financial goals because you were too scared to stay invested. Second, focus on time horizon.

Speaker 1 If you don't need this money for 20 years, a 10% decline today is a meaningless noise, statistical static, a blip that will be invisible when you look back.

Speaker 1 I've said this before, but worth repeating here. If you have a long time horizon, you haven't lost money, your investments are simply worth less as of this moment.

Speaker 1 But you weren't planning on selling during this moment. So in fact, it's an opportunity even to buy more at lower prices if you're still contributing.

Speaker 1 Third, and I cannot stress this one enough, please limit how often you check your portfolio. Seriously, stop it.
Put down your phone. Step away from the computer.

Speaker 1 If checking your account balance makes you anxious, you're checking too often. Once a quarter is plenty.
Once a year, arguably better. Possibly optimal for most people's psychology.

Speaker 1 The market doesn't care how often you look at it. It's not a souffle that's going to fall if you peek, but your psychology will care.

Speaker 1 This is why I personally limit big time how much I invest in individual stocks, because we're way more apt to check if we're looking at individual holdings than if we just own the entire haystack.

Speaker 1 Finally, as always, automate your investing.

Speaker 1 If you've been listening to the show for a few months and still haven't automated your investments, stop wasting your time with me and start optimizing your life by doing that right now.

Speaker 1 Set up regular contributions regardless of market conditions.

Speaker 1 It's dollar cost averaging, which is a fancy term for buying regularly whether the market is up or down because we don't even know what up or down means.

Speaker 1 When you're automatically buying during downturns, you're turning loss aversion on its head. Declines become opportunities rather than catastrophes, sales rather than disasters.

Speaker 1 Finally, one of my favorites, bias number five, hindsight bias. The I knew it all along effect.
Except, no, you didn't.

Speaker 1 Hindsight bias is the tendency, after an event has occurred, to believe you knew it all along, that the outcome was predictable, even obvious, even though at the time it was anything but.

Speaker 1 It's why people claim they knew the housing market would crash in 08, or that they saw the dot-com bubble coming, or that they predicted COVID would crash the market.

Speaker 1 In reality, you didn't, or you would have acted on that knowledge and become very, very wealthy.

Speaker 1 And because you're not very, very wealthy from that foresight, we can safely assume we're all engaging in historical revisionism.

Speaker 1 In investing, hindsight bias is particularly insidious because it makes us overconfident about our ability to predict future events, which then leads to all the overconfidence problems we discussed in number one.

Speaker 1 It's a cascading failure of reasoning. We look back at market history, and it all seems so clear, so obvious, so inevitable.
Of course the market crashed in 08. The signs were everywhere.

Speaker 1 Look at all that subprime lending. As if you had any idea what subprime lending even was before you saw the big short, or even after you saw the big short.
Of course tech stocks exploded in the 1990s.

Speaker 1 It was the internet revolution. How could anyone have missed it? Well, because we all did.

Speaker 1 But this is our brain, rewriting history to create a coherent narrative, like editing a movie to make the plot make sense. At the time, these events were murky, debated, and highly uncertain.

Speaker 1 There were warning signs, sure, but there are always warning signs somewhere if you look hard enough. There were also signs that things would be fine.
There were experts arguing both sides.

Speaker 1 Uncertainty was everywhere, as it is today. But after the fact, we forget the uncertainty and remember only the outcome, which makes it seem like the outcome was obvious all along.

Speaker 1 Hindsight bias also makes us way too harsh on ourselves and others in a way that's neither fair nor useful. You bought a stock that subsequently crashed and you think, how could I have been so stupid?

Speaker 1 The warning signs were everywhere. A child could have seen this coming.

Speaker 1 But the warning signs weren't everywhere, or at least they weren't clear warning signs versus the thousand other signals that you were processing.

Speaker 1 This harsh self-judgment makes investing feel more stressful and leads to worse decisions because you become afraid to make any decision at all.

Speaker 1 It also affects how we evaluate advice and advisors in spectacularly unfair ways. If someone recommended a stock that went up, we think they're brilliant, possibly clairvoyant.

Speaker 1 We should listen to everything they say. If it went down, we think they're incompetent, possibly fraudulent, we should ignore them forever.

Speaker 1 But in both cases, the recommendation might have been perfectly reasonable given the information available at that time.

Speaker 1 But we're judging based on outcomes, not process, which is like judging a poker player's decision based on whether they won the hand rather than whether they played the odds correctly.

Speaker 1 Sometimes you might make the right decision and lose anyway. That's variance, that's luck, that's life.

Speaker 1 This connects to the narrative fallacy, our tendency to create coherent stories to explain events after they occur.

Speaker 1 We can always explain why the market crashed or rallied, and these explanations feel satisfying and true and complete. Just look at the entire study of history.

Speaker 1 The crash happened because of subprime mortgages. That rally happened because of Federal Reserve policy.

Speaker 1 But these explanations are often wrong, or at least oversimplified, or cherry-picked from dozens of factors.

Speaker 1 The real causes, as we all know if we admit it, are complex, multifaceted, interactive, and almost always unknowable.

Speaker 1 But our brains hate this uncertainty more than they love accuracy, so we create tidy little narratives that make the past seem predictable and make us feel like we understand what happened and are in control of the future.

Speaker 1 The danger is that this false confidence in our understanding of the past makes us so overconfident about predicting this future.

Speaker 1 If you believe you knew the market would crash in 2020 when COVID hit, that you saw it coming, that it was obvious, you're going to believe you can predict the next crash, but you can't.

Speaker 1 Almost no one can consistently predict major market moves, and the few who do are likely lucky rather than skilled, because luck is often indistinguishable from skill in the short term.

Speaker 1 Fighting hindsight bias requires deliberate effort and systematic defenses. One technique.
Keep a decision journal.

Speaker 1 Write down your investment decisions and the reasoning behind them at the time that you make them. Not after, once you knew the outcome, but before.

Speaker 1 Then, when you review those decisions later, you can evaluate your process rather than just the outcome. Judge your reasoning rather than your results.

Speaker 1 You'll often often find that decisions that led to poor outcomes were actually reasonable given what you knew, and decisions that led to good outcomes might have been lucky guesses or even bad reasoning that just happened to work out.

Speaker 1 Also, embrace uncertainty.

Speaker 1 Accept that investing involves lots of unknowable variables, that the future is fundamentally unpredictable in the short term, and that even good decisions can lead to bad outcomes and vice versa.

Speaker 1 Judge yourself on whether you followed a sound process. Diversification, low costs, regular rebalancing, appropriate risk, not on short-term results, which are largely noise and mostly nonsense.

Speaker 1 Finally, be deeply skeptical of anyone claiming they predicted a major market event, especially if they only mention it after the fact.

Speaker 1 Yes, some people predicted the 08 crash, but thousands of people predict a crash every single day. Just turn on the news and eventually someone will be right.

Speaker 1 Like a broken clock being right twice a day, or like buying lottery tickets every week and eventually winning and claiming you knew your numbers would hit.

Speaker 1 The question isn't whether someone predicted one event, but whether they've consistently made accurate predictions over time

Speaker 1 and whether they acted on those predictions with their own money. Spoiler alert.
Basically, no one has done this consistently, and the ones ones who claim to have are usually selling you something.

Speaker 1 And there you have it. Those are the 1.0 five behavioral biases that are systematically, methodically destroying your investment returns like termites in your financial foundation.

Speaker 1 Overconfidence, making you trade too much and diversify too little, convinced you're smarter than the market.

Speaker 1 Recency bias, causing you to chase performance and time the market badly, daily, convinced that whatever just happened will keep happening.

Speaker 1 The endowment effect, making you hold on to investments you'd never buy today, convinced that ownership confers some type of special value.

Speaker 1 Loss aversion, making you too conservative and too prone to panic, convinced that avoiding pain is more important than achieving gains. And hindsight bias.

Speaker 1 giving you false confidence in your ability to predict the future based on some revised history of the past, convinced that everything was obvious in retrospect.

Speaker 1 These are the greatest hits, as I mentioned, of behavioral economics for a reason. They're powerful, pervasive, and destructive.

Speaker 1 And here's something to think about that I need you to really internalize. Knowing about them doesn't make you immune.
I know about all of these biases. I've studied them.
I've read the research.

Speaker 1 I've written about them. I've talked about them on this podcast.
And I still catch myself committing them daily. In the form of, I think I'm a better driver than many people on the road.

Speaker 1 Most other people on the road would probably say otherwise.

Speaker 1 The difference is that I've built systems to protect myself from my own brain, like a financial alarm system that goes off when I'm about to do something absolutely silly.

Speaker 1 That's what I want you to take away from this episode. You can't eliminate these biases through willpower alone.
Willpower is a finite resource and markets are very good at exhausting it.

Speaker 1 You need systems, structures, rules that operate regardless of your emotional state, automatic contributions and rebalancing to combat loss aversion and recency bias, a written investment policy statement created when you're calm to fight overconfidence, regular portfolio audits asking, would I buy this today to combat the endowment effect, and a decision journal to fight hindsight bias and track your actual reasoning versus your remembered reasoning.

Speaker 1 Next week in part two of this series, we'll dive into five more behavioral biases, ones you probably haven't heard of quite as frequently, but that are equally, if not more, destructive to your returns.

Speaker 1 We'll talk about the disposition effect, the ostrich effect, mental accounting, the gambler's fallacy, and the action bias.

Speaker 1 These are genuinely deep cuts, the lesser known biases that are still costing you serious money, possibly more than the famous ones, because at least people are watching out for overconfidence.

Speaker 1 Not many people I know are watching out or know about mental accounting. Here's your homework before next week, your actual assignment.

Speaker 1 Pick one bias from today's episode and implement one specific concrete defense against it.

Speaker 1 Maybe you commit to checking your portfolio only quarterly instead of daily and you delete the app from your phone to just remove the temptation.

Speaker 1 Maybe you write down your investment thesis for each holding and evaluate whether you'd buy it today at current prices. Maybe you start a decision journal, just a simple notebook.

Speaker 1 Maybe you set up automatic contributions so your loss aversion can't stop you from buying during downturns. Just pick one thing and actually do it.
Not in theory, but in practice this week.

Speaker 1 Because successful investing isn't about being the smartest person in the room, having the best information, or predicting the future.

Speaker 1 It's about making fewer mistakes than the person sitting next to you.

Speaker 1 As always, hope this episode gives you something to think about throughout the week and looking forward to continuing the conversation with you all soon.

Speaker 1 Thanks for tuning in to your money guide on the side. If you enjoyed today's episode, be sure to visit my website at tylergardner.com for even more helpful resources and insights.

Speaker 1 And if you are interested in receiving some quick and actionable guidance each week, don't forget to sign up for my weekly newsletter where each Sunday I share three actionable financial ideas to help you take control of your money and investments.

Speaker 1 You can find the sign-up link on my website, TylerGardner.com, or on any of my socials at Social CapOfficial.

Speaker 1 Until next time, I'm Tyler Gardner, your money guide on the side, and I truly hope this episode got you one step closer to where you need to be.