Stephanie McCullough (00:00):

Our human brains are wired to be bad at money. That’s right. Human beings are bad at money. I didn’t say you are bad at money. I said human beings. What I appreciate about this field is that the psychologists came along and they’re like, “Hey economists, here you are going on and on about how human beings are perfectly rational. Well, we kind of look at human beings in the real world and we’ve actually never seen them be perfectly rational about anything else. Why do you think they’re perfectly rational about money? Money of all things.”

Stephanie McCullough (00:43):

Hey, dear listeners, we need to let you know that Kevin and Stephanie offer investment advice through Private Advisor Group, which is a federally registered investment advisor. The opinions voiced in this podcast are for general information only and are not intended to provide specific advice or recommendations to any individual. To determine which strategies or investments may be suitable for you. Consult the appropriate qualified professional prior to making a decision. Now, let’s get on with the show.

Stephanie McCullough (01:18):

This is Take Back Retirement, the show that’s redefining retirement for women. Retirement is an old-fashioned cultural concept. We want to reclaim the word so you can make it your own. I’m Stephanie McCullough, financial planner and founder of Sofia Financial, where our mission is to reduce women’s money stress and empower them to make wise holistic decisions so they can get back to living their best lives.

Stephanie McCullough (01:41):

Kevin Gaines is my longtime colleague with deep knowledge in the technical stuff: investments, taxes, retirement plan rules. He’s a little bit geeky and quantitative, I’m a little bit touchy-feely and qualitative. Together, through conversations and interviews, we aim to give you the information and motivation you need to move forward with confidence. We’re so glad you’re here.

Stephanie McCullough (02:08):

In 2002, the Nobel Prize in Economics was awarded to two men. One was an economist, makes sense, Nobel Prize in economics, going to an economist. The other was a psychologist named Daniel Kahneman. And what the Nobel Committee said was they awarded it to him “for having integrated insights from psychological research into economic science, especially concerning human judgment and decision making under uncertainty.”

Stephanie McCullough (02:38):

Well, I don’t know of any money decisions that don’t involve uncertainty. So, it makes sense to me that the Nobel Committee recognized Kahneman and then again in 2017, Richard Thaler for an area that we love called Behavioral Finance.

Stephanie McCullough (02:58):

Coming to you semi-live from the beautiful Westlakes office park in suburban Philadelphia, this is Stephanie McCullough and Kevin Gaines of Sofia Financial and American Financial Management Group. Say hello, Kevin.

Kevin Gaines (03:09):

Hello Kevin.

Stephanie McCullough (03:10):

So, today we’re going to talk about my favorite area, which is called behavioral finance. And I love it because to me it proves that the money mistakes that you have made, that I have made, they’re not actually evidence of a character flaw. They’re just proof that we are human beings because our human brains are wired to be bad at money. That’s right. Human beings are bad at money. I didn’t say you are bad at money. I said human beings. What I appreciate about this field is that the psychologists came along and they’re like, “Hey economists, here you are going on and on about how human beings are perfectly rational. Well, we kind of look at human beings in the real world and we’ve actually never seen them be perfectly rational about anything else. Why do you think they’re perfectly rational about money? Money of all things.”

Kevin Gaines (04:09):

Yeah. I mean, because well money is a very bland topic, you know. It’s not like you know anybody sits there and worries if they make more money than their neighbor or if they can spend more money than their neighbor or if their brother or sister retired before they did or went to a more prestigious school. Yeah, I mean, none of that exists.

Stephanie McCullough (04:31):

Oh, and you’re saying it’s not tied up into our feelings of personal worth and security and relationships and career and family. Yeah, of course, money is going to be fraught.

Kevin Gaines (04:46):

Yeah. Because we did that whole series on divorce and never once did money come up as a topic.

Stephanie McCullough (04:52):

Or emotions. Right?

Kevin Gaines (04:55):

Yeah. Wow. Man, what are the odds? But one thing we’re talking about here, so the internet, God bless the internet, they love their clickbait. Just trying to throw out some sensationalized headline to get you to click and read it. And we all fall for it eventually.

Kevin Gaines (05:12):

But we’re not talking about a clickbait headline here, six tricks to get you to save more or anything like that. What behavioral finance really is, is understanding how the engine works, you know. This is how we are wired; this is how we’re going to act and react. And if we can understand that, then we can go about our work.

Stephanie McCullough (05:40):

Well, and that’s the cool thing to me, is that this really is science-based. So, it’s not just like, oh yeah, humans are irrational about stuff. The cool thing about this is that there is actually common shortcuts, mental shortcuts that we take around money and financial topics. They’re actually called biases by the researchers. And we’re going to talk through a few.

Stephanie McCullough (06:05):

But first let me share my favorite book title. Yeah, the book’s good too, but the title is what really gets me. So, it’s a book by Dan Ariely, professor from Duke University. And the book is called-

Kevin Gaines (06:20):

There’s a shock.

Stephanie McCullough (06:22):

Predictably Irrational. So, his point is that yes, human beings are irrational about money, but we’re actually irrational in predictable ways. So, this is where we find the most useful takeaways in my mind from behavioral finance. Because once we know kind of the, the pitfalls, the shortcuts that humans tend to take, then we can be aware of them. Then maybe we can make different decisions.

Stephanie McCullough (06:53):

Kevin loves the title of this next one. It’s called the Gambler’s Fallacy. And the idea-

Kevin Gaines (07:00):

Actually, I have to interrupt you, Stephanie. I actually hate this one.

Stephanie McCullough (07:05):

You hate this one. Why?

Kevin Gaines (07:07):

I hate this one because it exposes me to myself in ways I just really, really hate to admit.

Stephanie McCullough (07:16):

You’re uncomfortable with this?

Kevin Gaines (07:17):

Yeah, what’s the old expression? Hits a little too close to home.

Stephanie McCullough (07:21):

Uh-huh.

Kevin Gaines (07:22):

Oh yeah, this lands dead center. And I have, well several embarrassing stories, but continue and I’ll share one with everybody in a moment.

Stephanie McCullough (07:33):

Okay. So, to me, the best example of this is if you imagine that I’m flipping a coin, so I’m going to flip the coin six times and then you’re going to try to guess what the seventh flip is going to be. So, in this particular series, I flip the coin six times and I get heads, tails, tails, heads, tails, heads. And you think to yourself, okay, what do you think the next flip’s going to be? And then the second time I do this, I’m going to flip it again six times. And this time I get heads, heads, heads, heads, heads, heads. And what do you think the next flip’s going to be?

Stephanie McCullough (08:13):

When I do this in a room of live people, a lot of people say they think it’s more likely to be tails. And yet when we think about it rationally, we know that the flip of a coin is not impacted by the flips that came before it. Every single flip of the coin has a 50/50 chance of landing on one side or the other unless it’s a doctored coin.

 

 

 

Stephanie McCullough (08:37):

So, the fact that I already had six heads in a row doesn’t make the next flip any more likely to be tails. And yet, because we are human beings with these lovely brains, we’ve got, we want to see patterns, we want to think we can predict things.

Stephanie McCullough (08:53):

Oh my gosh, there’s been a whole lot of heads, there’s much more likely to be tails. I’m going to bet on tails. And thus, the word fallacy in the name of this one.

Kevin Gaines (09:03):

The problem is as humans we’re just too smart. So, we look for explanations where none exist. Oh, this happened, so whatever happened before it must have been the reason it happened.

Kevin Gaines (09:20):

And sometimes it just isn’t. Sometimes it’s just random. I mean, and casinos are built around this and the next one we’re going to cover as well, except they understand behavioral finance probably better than anybody else out there, except they go on the other side of it, and they make bookoo bucks.

Kevin Gaines (09:49):

And if you question how successful they are, look at how big their buildings are. There’s a saying amongst us gamblers, “Casinos are not built by the winners.”

Stephanie McCullough (10:04):

So, the interesting thing is that the ability to put together, to connect the dots, to find patterns actually is a useful skill in the world. If maybe a bunch of people ate berries from that bush over there back in our hunter/gatherer days and most of them got sick, you might think, “Ooh, I’m not going to eat those berries because it’s very likely I’m going to get sick.” That is true. That makes sense in the world.

Stephanie McCullough (10:34):

However, when that information is transplanted or when that assumption is transplanted to the world of money and to the world of investing in particular, it does not actually serve us because that’s not how the system is built.

Stephanie McCullough (10:51):

Kevin, there’s something called the behavioral gap in investing. Can you explain?

Kevin Gaines (10:56):

To this point, there’s a well-known study amongst us advisors and every year we look at it and what it shows is the average return of a variety of different types of investments, stocks, bonds, commodities, foreign stock markets, foreign bond markets, cash, it’s all over the place and-

Stephanie McCullough (11:21):

Real estate, et cetera.

Kevin Gaines (11:22):

I mean, and the returns are whatever they are, but then there’s this other bar and most years it’s one of the smallest bars in this bar chart, meaning it has the lowest return, it’s investor performance. So yes, this S&P 500 U.S. stock market averages a return of roughly 8% per year. But what is the average return for the investor? On any given year, it’s half at best.

Stephanie McCullough (11:57):

Or lower sometimes it’s like in the twos. Yeah. And what they mean is the average kind of retail, regular Joe investor or regular Jane.

Kevin Gaines (12:09):

And frankly, some of the professionals as well are perfectly capable of putting up some weird numbers relative to what the index did. And it’s because we’re human, we make mistakes. We engage in these biases and fallacies and next thing you know, hey the stock market did this, why did I only do that?

Stephanie McCullough (12:35):

Right.

Kevin Gaines (12:37):

Which is a great reason to hire a financial advisor because if you don’t beat the index, you can yell at your advisor for not doing it. As opposed to doing it by yourself. You can only yell at yourself.

Stephanie McCullough (12:47):

Yeah. Much more satisfying to yell at someone else.

Stephanie McCullough (12:50):

But you know there’s a lot of this tendency to think we can predict; think we can see a pattern which comes from the Gambler’s Fallacy. And then there’s another bias that we were going to talk about Kevin, which also plays havoc with our investment performance.

Kevin Gaines (13:08):

So, back when I was a young dumb gambler as opposed to today when I’m an old dumb gambler, I was at the casino and I was playing whatever table game I was playing and behind me was the roulette wheel, which is not a game I particularly enjoy, but a lot of other people do. And I keep turning my head looking at it because attached to every roulette wheel is this screen and it shows the last 20, 25 spins what the results were.

Stephanie McCullough (13:46):

Oh, my gosh.

Kevin Gaines (13:48):

Just about every roulette wheel has this, going back to my analogy that the casinos have figured out behavioral finance before anybody else did. This thing has been around forever, and this is why, to prey on young dumb gamblers.

Kevin Gaines (14:03):

In my particular case, the numbers were immaterial to this thing, but there had been 13 blacks in a row. Now to explain roulette real fast, it’s divided series of numbers. Half are black, half are red, half are odd, half are even.

Kevin Gaines (14:25):

So, you’re sitting there looking at this board and it’s like, wow, 13 blacks in a row, surely red is due to come up. So, I jump out of the one table game I was playing over to the roulette wheel, and put a bunch of money on red. Yeah, black hit. So, it was like, well crap.

Kevin Gaines (14:52):

So, I put more money on because now red really has to hit. Black. So, then I take the rest of my money, put it on red because there’s no way in hell it’s not coming up red this time. Black. So, I’m now busted. And just to show the ultimate of dignity, the next spin was red.

Stephanie McCullough (15:17):

After you were broke.

Kevin Gaines (15:19):

After I was broke. So, not only do we have non-existent patterns, but also looking at the most recent occurrences, voila, I assume that what has happened is I can define the future result. Yeah, not so much.

Kevin Gaines (15:43):

So, that leads us to Recency Bias, which is the assumption of what has happened most recently is the longer-term pattern. If the stock market has been going up recently, then that’s going to dictate what happens next.

 

Kevin Gaines (16:05):

Now in most cases, people make the assumption, oh, if it has been going up, it’s going to continue to go up and we actually have an acronym for that. We call it FOMO, Fear of Missing Out, which is, oh my gosh, everybody’s getting rich, everybody’s making money and that will continue. So, I need to get in now so I can continue that trend and I can get rich too.

Kevin Gaines (16:31):

Yeah, doesn’t work very often. That’s how you get bubbles. Some of us remember the tech bubble from the turn of the century.

Stephanie McCullough (16:41):

Oh yes, I lost some money in that one.

Kevin Gaines (16:43):

Probably the most — yes. No, the most famous bubble of all is the tulip bulb bubble. Happened in the Netherlands back in the 1600s. But yeah, people were taking their whole life savings to literally buy tulip bulbs.

Kevin Gaines (17:03):

But it became a craze. And you have this huge FOMO, you hear these stories of these prices going up, people buying a tulip bulb on one day, selling it the next for twice the amount. Why would you not want to do that? And if it’s been going up, then it’s got to keep going up because it’ll never go down because this is the greatest thing. Yeah, it didn’t end well then and it’s never ended well ever.

Stephanie McCullough (17:37):

Well, in another example I read about on Recency Bias, it’s also sometimes called Availability Bias. The information that’s available to you affects your perception of the likelihood of something happened, of probabilities.

Stephanie McCullough (17:52):

So, deadly shark attacks are actually not that common. And yet, no thanks to Shark Week, when there is a report (as there was not too long ago in the New Jersey shore area, which is not too far from us), of an attack by a shark, regular old people going to the beach feel like it’s much more likely. Because they’ve heard about it recently and therefore their assumptions about the probability of becoming a victim is that it’s higher because it happened recently.

Stephanie McCullough (18:33):

Now unless the shark is right there still in the water with you, the probability actually hasn’t changed.

Stephanie McCullough (18:42):

Okay. So, I’m going to tie this one to Kevin also, because Kevin’s got a pile of cash sitting on his desk for a particular reason. The third bias we want to share with you today is something called Mental Accounting. And that means that even though we know that a dollar is a dollar is a dollar and the same dollar will still buy you a coffee from McDonald’s or wherever you choose, no matter where that dollar comes from, that’s not actually how we treat money.

Stephanie McCullough (19:15):

Human beings put different values on money based on where the money came from. So, for example, there was a study that was done at the University of Chicago and also at Harvard with a bunch of students. And in the study, they gave all the students $25, but half of the students were told it was a rebate of their tuition money. And the other half were told it was a bonus for participating in this study. And then they studied, and they tracked how the students spent the money.

Stephanie McCullough (19:49):

Well, 84% of those who were told it was a bonus spent some or all of it. Whereas only 21% of those who were told it was a rebate of their own money spent any of it at all. So, the behavior was very different based on what they were told the significance of this money was.

Stephanie McCullough (20:11):

So, for another example, if you have ever — back in the days when we used cash people, if you ever pulled out a winter coat, say in October when it was starting to get chilly and you found a $20 bill in your pocket and you’re like, “Woohoo,” did you treat that $20 bill differently than if you had to go to the bank and take it out? Again, back in the cash days.

Kevin Gaines (20:30):

Were you ever a Hollywood writer?

Stephanie McCullough (20:33):

I was not.

Kevin Gaines (20:34):

Did you ever write sitcoms? Well, because that last example is a Seinfeld episode.

Stephanie McCullough (20:41):

Seriously?

Kevin Gaines (20:41):

There’s an episode of Seinfeld in which Jerry becomes convinced that he breaks even. No matter what happens, it’s going to balance out something good happens, something bad will happen, vice versa.

Kevin Gaines (20:53):

So, he’s talking to Elaine about this. So, she goes, “Let’s test something.” She goes, “Give me a 20.” He hands her a $20 bill, she wads it up, she throws it out the window. “Why did you do that?” She goes, “Let’s just see.” And two seconds later he reaches into his pants that he had just put on. He goes, “Oh my gosh, I got a $20 bill. You broke even.” And just then George walks through, he goes, “Hey, I just found $20.” Now let’s do the math. Okay? Jerry had $20 in his wallet, and he had $20, although he didn’t know it, in his pants pocket, he had $40. $20 went out the window into George’s pocket, eventually. Jerry’s really $20 poorer. Instead of having 40, he now has 20, yet to everybody in that apartment Jerry broke even. There’s Mental Accounting.

Stephanie McCullough (22:01):

Right, completely. We see it too with people who get a tax refund in April. They file their taxes; they get a check back in the mail. That check is not found money. That check is money that you paid in to the IRS throughout the year, either in your estimated taxes or from your payroll withholdings that was above what you owed.

Stephanie McCullough (22:26):

So, the government held it, paid you no interest and then they’re sending you a check back. But people use it like, oh it’s so exciting. They take a vacation with it. I guess it’s kind of a forced savings mechanism, but that’s another example of Mental Accounting. Kevin, you want to explain about the pile of cash on your desk?

Kevin Gaines (22:47):

Since Stephanie outed me? Yes, I do have a pile of cash sitting on my desk. And typically, what’ll happen is whenever we decide to order a lunch in the office, I’ll put it on my credit card because I love credit card points. I’m all about getting my reward points and everything from the credit card. So, I take cash from everybody, and I put it on my charge card so I can get the points.

Kevin Gaines (23:18):

Now what I should do is then take that money, put it in the bank, and then use that to pay off the credit card. No, no, no, no, no. That’s way too rational. No.

Kevin Gaines (23:31):

So, I’ve got this pile of money that people give me for buying lunch, for their share of lunch or whatever. And whenever the mood strikes, it’s like, “Hey, I think I’m going to pop over to the casino. Let me grab my gambling money.”

Kevin Gaines (23:53):

Is it gambling money? No, it was money that I already paid for other people’s lunches for. But yet in my mind, oh there’s gambling money, it’s free money. So, that way when I lose, not if I lose, when I lose, it’s not painful. Well, it wasn’t my money, trust me, it sure as hell was my money and I sure as hell lost it.

Stephanie McCullough (24:20):

Okay. But do you use this to your advantage at least a little bit in that when the pile of cash is gone, are you done gambling for the day?

Kevin Gaines (24:29):

Yes, yes. Which is so I have a gambling budget.

Stephanie McCullough (24:35):

Yeah.

Kevin Gaines (24:35):

Yes.

Stephanie McCullough (24:36):

It limits the downside. Whereas if you were just putting it on your credit card at the casino, there might not be a limit to the downside.

Kevin Gaines (24:49):

Right. And that’s another point about behavioral finance. Although all the stories we tell, especially the ones I’ve been telling about myself, have not necessarily been the best of stories. Some of these behavioral finance points can be a benefit such as mental accounting, used the right way. Yes, it can help you compartmentalize, can help you budget and say, “This is that type of money, I’m going to use it for that.” Going back to your point about tax refund. Yes, some people use it as forced savings, they’re going to turn around when they get that tax refund. Yes, they do it, maybe they pay for a vacation, but maybe that’ll also allows for them, oh, I need a new roof. Or we’ve got, I need to get a new car, we’re going to get the tax refund in a couple months, we’ll use that money to pay for the car.

Kevin Gaines (25:49):

So yeah, so not everything we’re talking about is “bad.”

Stephanie McCullough (25:55):

Yeah, it’s just that it’s usually unconscious. So, what I like to do, and why I think it’s so important to share these findings from behavioral finance is like let’s flip them and use them to our advantage.

Stephanie McCullough (26:07):

So, as Kevin was pointing out for the Mental Accounting, I am a big advocate of people having multiple savings accounts at a bank that’s not going to charge you fees for that. And then giving them different names, so you can have one saving account that’s specifically for taxes or for vacation or for buying your next car.

Stephanie McCullough (26:29):

And that way, instead of just having a pot of money in savings, that you’re more liable to grab some from if you want a big night out or want to buy some new shoes, you’re less likely to pull money from the vacation account to buy a superfluous pair of shoes you don’t really need. Or maybe that’s just me.

Stephanie McCullough (26:48):

But if the account says vacation, that feels a little bit more sacred than if it’s just the savings account. So, I think there are ways to use this to our advantage.

Kevin Gaines (27:01):

Yeah, I mean banks used to make this easier for us. They used to have the club accounts, the vacation club, the Christmas club, there was even one called the, you name it club, understanding that people like … yeah, yeah, yeah. When I was growing up, the credit union we used, I mean, so that was my savings account was the, you name it club.

Kevin Gaines (27:22):

And yeah, I mean that gets a little bit fuzzier so you can use it for more things. I mean, at no point was the bank going to punish you if you took the money out for its unintended purpose, but it made it easier for everybody.

Stephanie McCullough (27:36):

So, I think it’s important that people have this awareness that the human brain is actually wired to trip us up, to shoot ourselves in the foot when it comes to money and investing.

Stephanie McCullough (27:53):

So, what should we do about that? To me, the ideal information to take away is like, oh, these things might be going on. So, how can I make it a little bit more on the conscious level. If you’re making some decision, back up a second and say, wait, what information am I using to make this decision? And is it a presumption, an assumption I’m making? Am I going on something I just heard at lunch or recent information or am I assuming some trend is going to continue? A little bit of self-examination can help pull us out of these kind of knee-jerk reactions.

Kevin Gaines (28:37):

Right. I mean, and even if you are doing things rationally, just taking that extra 30 seconds to take a step back, take a breath and say, am I doing this for the right reasons are the wrong reasons? Or I’m using the biases kicking in. You can feel a little bit more confident in the decisions that you’re making. You’re doing them for “the right reasons.”

Kevin Gaines (29:03):

And no, it’s no guarantee that it’s still going to work out the way you want it to, but believe it or not, it’s probably going to increase your chances of success in whatever we’re talking about. I like to think of it how NBC, they have their little PSA announcements and it’s got the little logo of the more you know, that’s what we’re talking about here. The more you know.

Stephanie McCullough (29:31):

And to me the biggest takeaway, the biggest gift of behavioral finance is that we can set down the guilt, the shame that we carry around for our past financial mistakes. For that time that I bounced the check to daycare, because my recency bias was I take a peek at the bank account balance and there was enough in there. So, I wrote the check forgetting that the mortgage was coming out the next day.

Stephanie McCullough (30:03):

We do these things. Our brains take these shortcuts, these mental shortcuts, precisely because this stuff is fricking complicated, it’s complex and it is emotional. So, please give yourself some grace. Let yourself off the hook for any financial mistakes that you feel you’ve made in the past.

Stephanie McCullough (30:22):

It’s actually not a character flaw. You’re not a terrible person. It’s this lovely human brain we’ve got that actually is not so good at the money and investments.

Kevin Gaines (30:33):

No, I think this was a good introduction.

Stephanie McCullough (30:37):

We will certainly be touching on the topic of behavioral finance again in the future. It’s one of my favorites. I think it’s just so much rich information and there’s a lot of cool experts out there. So, we’re going to be reaching out and trying to get some other cool people to talk to you about this. For right now, I want to thank you for being with us. We’ll talk to you next time. It’s goodbye from me.

Kevin Gaines (30:58):

And it’s goodbye from her.

Stephanie McCullough (31:02):

Be sure to subscribe to the show and please share it with your friends. Show notes and more information available at takebackretirement.com. Huge thanks for the original music by the one and only Raymond Loewy through New Math in New York. See you next time.

Disclaimer (31:17):

Investment advice offered through Private Advisor Group, LLC, a registered investment advisor. Private Advisor Group, American Financial Management Group, and Sofia Financial are separate entities. The opinions voiced in this material, are for general information only and are not intended to provide specific advice, or recommendations for any individual security. To determine which investments may be appropriate for you, consult your financial advisor, prior to investing. This information is not intended to be substitute for individualized tax advice. Please consult your tax advisor regarding your specific situation.