What Real Financial Advice Means with Carl Richards (EP.100)

0:28We all need to make smart decisions with our money. certified financial planner, and creator of the Sketch Guy column, appearing weekly in the New York Times since 2010. I have been a huge fan of Carl's sketches for so long because they make complex financial concepts easy to understand. And these sketches, they also serve as the foundation for his two books, The Behavior Gap, Simple Ways to Stop Doing Dumb Things with Money, and the one-page financial plan, a simple way to be smart about your money. In this episode, I asked Carl to talk about some of my favorite sketches, and my goodness, the conversation just keeps getting better and better as we go deeper into important financial conversations and what real financial advice means.

1:15So without further ado, here is my conversation with Carl Richards. Welcome to the Long-Term Investor, Carl Richards. Thank you so much for joining me today. Peter, it's an honor. Super jazzed about this conversation. I have been following your work for ages. And I even remember the first time that I lined up in a giant line to have you sign my book in Seattle at a CFA annual conference. And I'd watched you give a presentation doing your classic Sharpie sketches, but with an iPad and thinking it's just so incredible how you're taking all these big ideas and simplifying them down into something that's so digestible for people who don't want to think about this stuff each and every day.

2:03And so what I was hoping to do is kind of go through some of my personal favorite sketches. Now, obviously, everyone's listening. There are some of us watching on YouTube, but I'm going to have to do my best to describe the sketches. But fortunately, Carl, you so clearly communicate these things that I don't think I'm going to have a problem with that. And so with that in mind, I think perhaps your most famous sketch, and please correct me if I'm wrong, but it's one that I always see associated with your name, is a bar chart. And there are two bars. There's one bar that says investment returns, and it is towering over a second bar that is investor returns.

2:40And then you have what is the gap and you label it the behavior gap. So let me just start there. Pretty open-ended because you can go a lot of places, but what is the behavior gap? That's such a good question. And one of the reasons that was one of the earliest sketches is because it will become apparent. It's kind of hard to describe, right? And it's a little bit hard to get your head around that original version of the behavior gap. So imagine the original version of the behavior gap for me came from this realization, and it sounds almost silly, that there's a difference between investment returns and investor returns.

3:18And getting your head around that is really, really important. And so the way I always explain it quickly is, imagine if you opened the newspaper and there was an advertisement for a mutual fund, and it said this mutual fund, this investment had a return of 10 % a year for the last 10 years. It averaged 10 % a year for the last 10 years. So we could label that bar graph 10%. You know, the average return of the investment was 10%. That's the investment return. But if you were to have put money in at the beginning of that time period and leave it there for the whole time period, not add any money or take any out, and if we don't think about taxes or any sort of costs, the question would become, what would your return have been?

4:06What would the investor return have been? Well, if you put the money in at the beginning, you left it there for the whole time, you didn't add or take any part, and we don't think about any costs associated. In that case, the investment return and the investor return would be the same. But who invests that way? I mean, I know your clients do. But most of the world, right, we are always looking for the next best thing. So we're constantly moving money in and out. And we're often, we sometimes call it the hot dot, right? We're often moving money into the thing that just did well, just in time for it to do its normal thing, some cyclical time where it doesn't do well.

4:44And then we sell it. We think we've got to find a new one. And we repeat that over and over. And so what I learned early in my career was that this well-intentioned search for the best investment often just naturally leads to behavior that costs us money. and I labeled that specific example was what the behavior gap started but now I think of the behavior gap as any well-intentioned behavior that produces a suboptimal result, right? So anytime we have a well-intentioned behavior that produces it and like I've got to save, save, save maybe a well-intentioned behavior that causes all sorts of fights at home.

5:26That's a suboptimal result, right? Like I've got to be frugal and now you're retired and you can't ever even go golfing because you don't know how to enjoy your money. That's a well-intentioned behavior that produced a suboptimal result. So that's the way I think of the behavior gap now. I really like that. I like the way that you're phrasing it. And oftentimes our human instincts, which you don't need to feel bad about. I think it's important for people to realize when we talk about these human instincts that are the exact opposite of what you need to be doing to successfully grow your money with investments, they're very natural.

6:02There's no need to feel bad about it. But being aware and talking and creating a platform where you say, oh gosh, I do have that happen can be useful because a lot of what happens and results in us making suboptimal choices, as you put it, it's just noise. And so I'm kind of curious, Carl, in your experience and all your conversations with people, why do you think it is that we pay attention to noise in the first place? Yeah. And Peter, thanks for saying it. Like to all the people listening, like you'll often hear people in the finance world, particularly as behavioral finances become a thing.

6:39There's often this almost smug, like look at the silly people making the silly mistakes. And I think it's really important for us to understand like deep empathy for all of that. Like I make the exact same mistakes with, I'm really good at helping other people not make those mistakes with their money. and if I didn't have help, I would make the same mistakes because we're hardwired to behave that way. Some of that wiring has literally kept us alive as a species, right? To get away from things that cause pain and to want more of things that give us security or pleasure. That's really important to heart genetic, like hardwiring.

7:20Well, the way it translates in the investing world is for whatever reason. Well, I know the reason. It has to do with your noise. Like when you turn on the Financial Pornography Network, otherwise known as CNBC, and you see people yelling and screaming, sell, sell, sell. It's bad. It's bad. It's bad. And then you go to the club and your friends are selling. That's now translated as that generates pain. And then we've got another behavior where we like to be part of a herd. Like you've been told your whole life, keep your head down. Don't cause trouble. Don't stand out. And in some cases, that's kept your family alive.

7:58And you know what happens if you get separated from the hurt. So now we've got all this behavior mixed in that actually is counterproductive. And so the noise piece to me is just like, we are wired for novelty. We're wired to be scanning the horizon, looking for danger. and when something yells and waves their hands a lot and looks dangerous, we're wired to pay attention to that. And the same on the opposite side, sort of maybe the greed and excitement side, like we're really like, man, if there's something exciting, something that can help me have more, something that can help me feel like I've got enough, something that helped me feel like I'm going to make it through the winter, like where are the buffalo?

8:40All of that stuff, you're like, well, I'm going to pay attention to that. That looks important. Everybody else is doing it. And, you know, that, of course, all changes once we realize that there's a big misalignment of incentives, that that's more like a circus, you know, an entertainment industry than it is valuable. But that's why I think we're attracted to noise is because we're wired that way. And Carl, a lot of my job is to help create context for the noise that our clients are hearing that my viewers are seeing and my listeners are hearing and reading. One of the charts, and actually I'm going to look at it so I describe it correctly here.

9:21I call it chart. I should call it a sketch. What do you call your drawings? What do you call them? We couldn't come up. It was such a problem. Cartoons, illustrations, that all implied a level of skill that I don't have. We finally settled on like sketch. It's just a sketch. Sketch works well. There's one bar chart you have, there are three bars and the charts titled what I need during a scary market. And the biggest bar is hugs. The next biggest bar, which by the way, is less than half the size of the hugs bar. That one is facts. And then the last one is lectures. And it's actually going in the opposite direction, implying that it hurts and doesn't help at all.

9:58And Carl, this was actually a really big moment for me in a career where I'm giving people guidance and you hear a rustling in the bushes. And if we were cavemen, and we don't have time to figure out the probability of it being a lion versus the wind, we just have to run. And for me to sit there and say, it's obviously not a lion. Lions don't live here. Those facts, while true, aren't always helpful. And I think understanding the real human need that sometimes this stuff is scary. And sometimes money is confusing. I guess I'm kind of curious how you came about thinking about this, creating what I think is, again, probably one of my favorite sketches because it applies the most to my everyday job.

10:43What are your experiences that led you to drawing this? Yeah, I mean, thank you. That's really thoughtful of you to find. That's one of my favorite sketches. And I often talk about like hugs first, lecture later, hugs first, facts later. And here's the reason when you have a well-designed and I know the type of work you do, right? Like, so you have a well-designed portfolio built on data and evidence. You've done some work to align that to the client's values and goals. So like as your listeners, you're thinking through like, if you're investing like an adult is the way I normally phrase it. Like you're well diversified.

11:21Your portfolio is designed specifically with your goals and values in mind. So there's a link there, which by the way, I'm not taking that for granted because most people, that's not true. Most people, it's like a smorgasbord of investments. They heard something, they bought it. It's like a collection rather than a portfolio. But I know that your listeners, and I specifically know the work you do, portfolio designs an intentional process. So if you've got a portfolio designed on purpose and then a scary market shows up, which they do, and you are reasonably nervous and please like deep empathy, like I am too, if I turn on the news, there's a reason you're worried.

12:03Selling that portfolio doesn't make a lot of sense with the benefit of like when you were thinking clearly, it doesn't make a lot of sense. I would go so far as to say it's, it may feel correct, but it's factually irrational. Like it's just irrational. So selling a long-term portfolio because of some short-term fear, even though it feels like it's the end of the world, that's an irrational decision. So we could argue that all day long. Is that irrational or not? But let's just for a minute pretend like it is. We can agree it's irrational. What I think we need to realize is when we're in the middle of making an irrational decision, the last thing we want is somebody to reason with us.

12:46Like try it with your teenager. The last thing you want is somebody to reason with you. You know what you want? You want somebody to understand you. Right? I actually get emotional about it because I see this so often. Can we just create a space where we can say, hey, John and Sue, thanks for calling. I understand why you're a little nervous. When I watch the news, I am too. And so first there's this sense of like shared compassion and empathy and a hug. And then maybe we need to back into later, like, hey, would it be helpful if we review exactly how we got here? And I can look you in the eyes and say, I got you.

13:30But I do need to double check, like, are we still in the same place? And then that then like some facts show up. But certainly the last thing we need, and I saw this a lot back in the day over the last 10 years on Twitter, where financial advisors would be like, don't be stupid and sell now. And you're like, that's the lecture piece. That doesn't help at all. Try it with your teenager. So I think what people want when they're nervous or scared, they're making an emotional decision. And this gets so confusing because we think that the money's all math, which is why I believe this is so important is because it's not.

14:07Like that poor, tell what? You thought this was a math problem? you're worried about whether you're going to end up under a bridge. You don't want to be like your mom or your dad. Or remember when your mom used to come in and say, or your dad used to come in and say, don't be spoiled. Like all of those things are in your portfolio. And so I think it gets a little confusing because you're expecting it to be rational. And then you're a little confused as to why you're feeling so scared or why you're in an argument with your spouse or why you're yelling at one of the kids. and you're like, wait, this is emotional.

14:42And then we, so we got to feel that first. And then of course, obviously like the work you do is deep mathematically, like that stuff's rockets. It's super important, but it's only important if it's linked to the values and goals. As soon as we get to values and goals, we get to emotion. And so I think that's how I think about that sketch. Well, I have no doubt that I'm going to talk about values and goals before I do. It does introduce me an opportunity to pivot a little from the investing side and dig into some of what I think you would agree are really important questions for people to think about themselves, for advisors to talk with their clients about.

15:21And if you don't have an advisor, that can be fine. But having some objective, trustworthy person to talk about these things. And so let me start with something I know you've written a lot about, talked a lot about, which is just simply why is money important in the first place? Yeah. Yeah, it's funny. It's almost the only thing I'm interested in talking about right now. I mean, I know why it's important to me. It's on the top of my one-page financial plan. There's a little thing called a statement of financial purpose, and it says, time with my family, mainly outside, and serving in my church and my community.

15:55Like, that's why it's important to me. And as long as I can keep that in mind, these other decisions, while they don't, like, they're not inconsequential, and they're not easy, but they become much easier, right? Like when the vision is clear, I can't say like a Disney quote or something. Like when the vision is clear, the strategy becomes much easier. And so I think, you know, why is money important? The answer, like to your listeners, especially if you don't work with an advisor, like, well, first of all, if you work with an advisor, go ask them to guide you through this conversation, like show up and tell them, like, here's a question I heard on Peter's podcast, I need you to ask me.

16:36And if you don't have an advisor, have this conversation with a friend or a spouse and just think through like what, and the answers that often come first are like investment performance, or I want to buy a second home, or those aren't really why. Like, why do you want to buy the second home? Well, I want to create memories with the kids. Okay, we're getting closer, right? Like, why do you want investment performance? I mean, I can take you real quickly through, like, I remember having this conversation with a couple and they had never thought about this because most people haven't. Actually, almost everybody I've ever spoken to hasn't.

17:14And we had this conversation sort of, why is money important to you? And her name was Julie. She said, I think she said, flexible freedom, freedom. And I was like, oh, that's good. And there's a consulting practice called the five wise. So it was like, go five levels deep freedom. I said, tell me more about that. Why is freedom important to you? And I'm shortcutting this. This is like a 15 minute conversation. Freedom. She said flexibility or she said freedom. Then she said flexibility. I said, tell me more about that. That could mean different things to different people. Why is flexibility? And she longer pause.

17:44And this is like a hard charging type A emergency room doctor. And she was the managing partner of the biggest emergency department in our city. So like just, and if you know about emergency medicine, it's like, you got to be on your game from med school on. And she was like, longer pause. And she says, time, like time, that's why money's important to me. And I was like, oh, let's pretend like you've got all the time you need. And we'll define that later, Julian. We'll call it a goal. We'll put some parameters around it. We'll call it a goal in a minute. But for a minute, let's pretend like you're there.

18:16Why is that important? There's this longer pause. And she gets a little emotional and says, Cara, I just want to have a family and I have not even had time to think about it. I was like, that's what we're talking about here. Like now it's so much easier for us to think about, well, how should the money be invested? How much should we be saving? What should we be doing? What does the insurance situation look like? All of those other things now suddenly have an anchor point because we've defined why it is important to you. I mean, I remember Jerry telling me, I just never want to be burdened to the kids.

18:49And we had to go deeper, but it was like, that's a great starting place. What does it mean to not be burdened to the kids? So that's to me how I think about that why. That's really great, Carl. I think people struggle to define their why. And I'm looking at a Venn diagram you've drawn where there's two overlapping circles. In one circle, it's use of your capital. The other is what is important to you. And then the overlapping section in the Venn diagram, you've labeled real financial planning. And it feels like we're already talking a little bit about this, but why don't you describe to me, how do you think about real financial planning?

19:28Yeah, I think real financial planning to me is that drawing. Like it's aligning your use of capital. And I now like an asterisk by capital. And the asterisk says time, money, energy, and attention. and you know you often don't think of like attention or energy when you're thinking about but those are all resources that we have and we want to align our use of capital with what we say is and i should be careful here with what is important to you and peter what just happened is i've been thinking that word say so align your use of capital with what you say is important to you that's what i used to say and i've been thinking about that word say for 10 years on some of these sketches that's what goes into that i've been bothered by the word say for like 10 years because it turns out i don't actually care what you say is important to you i what i actually really want to help you do is align your use of capital with what is important to you and sometimes those things are not the same and so i remove the word say now when i think about it it's like align your use of capital with what's important to you And the thing to understand, you said earlier, like very few people have thought about or get to define why.

20:43Please don't let that stop you. Like my dear friends, Peter's listeners, I don't know either. And it's a never ending process. us. So both sides of this Venn diagram, your use of capital. So it's like how you spend it, how you save it. Like that is going to be a revelatory process. Every time you do it, you're going to reveal something about yourself and you get a chance to say, does that match? Like for me, if somebody were to pull up my checkbook in the old days and my calendar, I'd be super curious if they could tell you there's that old saying the checkbook and the calendar never lie I'd be super curious if they could tell you what was important to me and what I hope they would say is time with my family mainly outside and serving in my community in my church but it's not often true and I can either be so crushed by that and say forget it or I can say okay what can I learn How could I make a little tweak here and a little tweak there?

21:51And realize I'm never going to seal that deal. That Venn diagram will always almost have a gap. Every once in a while, it looks like those two circles are perfectly overlapped. So it looks like one circle. I mean, I remember that night. It was Christmas Eve. The dog was on the couch, the whole family home. We've had our wonderful dinner. Everything's great. Perfect, perfect alignment. The next morning, with all the gifts, and I'm like, who bought it? My wife keeps pulling stuff out, and suddenly, boom. the gap opened again and I had to deal with that. So that's how I think of that is this never ending process of goal discovery and alignment.

22:27Yeah, I think what's really nice about that process too is there are a lot of successful people out there who make a lot of money, save a lot of money. Maybe they use an advisor, maybe they don't. But there isn't a clearly defined end game. There's a sketch I've pulled up. And by the way, for everyone listening or watching, you can go to the show notes at the longterminvestor.com. I'm going to put links to the articles where you can find these sketches and you can find all of Carl's great work. But there's a bar chart and one bar that's stretching out far says getting ahead and there's a shorter bar that's enough.

23:03And I think it's a challenge for a lot of people to realize where enough is and what enough means. How would you suggest people get their arms around this idea. Yeah, just written little experiments. It's really hard. Nobody taught us this. This concept of enough is like, again, one of my favorite topics right now. I would suggest that enough, I would humbly suggest that enough is not a destination. It's not a place you can arrive, and it's definitely not a number. I think enough is just something you have to be. and if it's ever a number, I promise you, and this is, I mean, like I'm tempted to do it too.

23:47Like I actually don't even believe myself about what I'm about to say, is if it's ever a number, it'll never be enough. Like I promise, I don't care what the number is. It will never, ever be enough. You'll get there and you'll be like, oh, that's not enough. And then the sad part about that is it's a double whammy. Not only is it not enough, but you're actually disappointed because it wasn't what you thought it was gonna be. I don't know that there's anybody who's had more conversations about money on the planet right now. Maybe I'm just in the top 10 or top 100, whatever. It doesn't really matter.

24:17But I've never had a conversation where somebody was like, oh, yeah, I thought once I had$3 million, it would be enough. And I got there, and it was. Like, I've never had that conversation. It's always the goalposts moving. There's science behind it, the hedonic treadmill. Like, there's always problems. so I would just suggest we need to decouple that idea if you're psychotic with money more money won't solve that problem if you're insecure with money more money will not solve that problem those those need to be decoupled it's different kind of work now once you've done that work there's actually some really cool research that was just updated Kahneman's research was just updated around the old rule we used to hear that like above 75 ,000 it doesn't generate any more happiness.

25:06And the update was, which was super fascinating. I just read the research on this. The update was when you separated for emotional wellbeing, if you're emotionally miserable, like if you're the lowest tier of emotional, well, it was thirds, the lowest third of emotional wellbeing, there was no correspondent. Like once you got to a hundred thousand dollars and income, there was no corresponding growth and happiness with more income. In fact, it caused more problems. But if you were emotionally in the top one third of emotional well-being, there actually was a corresponding link between happiness and more money.

25:46And that's probably, I assume, that's probably because you know how to spend it at that point. Like you're spending it on experiences with people you love. You're spending it on contributing to the society. you're spending it on volunteering, and that will increase happiness. So if you're miserable with a little money, you're going to be even more miserable with more. And so we just need to decouple those two, like do the work to figure out what enough is. And maybe a certain amount of money makes those conditions more favorable. The conditions of enoughness are a little easier when you have food on the table, for sure, right?

26:22Like there's no argument there. but beyond that we're expecting money to do a job it cannot do such an important point that you make and i also like that you point out how those who are in a good emotional state of being also probably make good choices with their spending the money and there's so much research on what type of expenditures tend to make us happy versus those that don't you had mentioned experiences I'm firmly in that camp and I've seen the research there. Now that doesn't mean everybody loves experience more than stuff, but there is a lot of research that says that you're going to remember that great trip with your friends or family when you're lying on your deathbed, not to get morbid than you are your most recent iPhone update or whatever gadget.

27:09But at the same time, buying something that creates more time. My wife and I have a standing babysitter every Saturday night. It is by far, I think our largest luxury expenditure, but it's also one that creates time for ourselves. There's a lot of research that giving to charity creates research that finding ways to make it a treat creates a lot of happiness. And I think even something as if you know what you're passionate about life and Carl, I've followed you a long time. I know that you're passionate about certain things. I've seen you write about buying a high quality bike because it makes you happy rather than cheaping out for lack of a better word and having to replace it all the time and not enjoying what is the thing that makes you so happy to be on this earth.