Episode 285: A Year in Review

26:43Okay, yeah, we are going to get into bubbles and innovations later. But before we progress on this, how informative do you think data from hundreds of years ago are about expected returns today? Well, you're asking a real financial question, expected returns, which means what kind of growth or benefits do I expect from owning like a share of stock or a part of the stock index today, on average, over months and years. So that is a puzzle for many people. And the reason for that is that returns that you get from investing are not stable. They vary quite a bit. And with that volatility, that volatility creates uncertainty.

27:30And it could take you 20, 30, 40 years to really understand what the expected return or what the average historical return is. But we like to think that once you've discovered something that makes money, it's going to keep on going before you can really put any kind of boundary on it at all. So as financial historians and financial economists, we're plagued by that uncertainty about what the expected return is. But history helps you because what I found in my research is that, well, over very long stretches of time, the stock market returns some amount in a relatively narrow band once you can control for things like inflation.

28:14So speaking of uncertainty, Will, if you were in our seats, so we help households make financial decisions, how would you estimate the expected long-term returns of both stocks and bonds? You're right to differentiate the two, although they do share some characteristics. For stocks, the starting place for me has always been the historical performance of the markets, both looking at the US market, but also comparing it to the world equity portfolio, which would take into account the failures as well as the successes. People often ask me, don't you think that the expected return has really changed because technology has changed?

28:57Strangely enough, it doesn't seem to have really ramped up the expected return particularly or changed it that much. So I think at least the basics are that you look at returns, but you really have to adjust for inflation because inflation has been a great shock since the first world war. So 100 years, we've experienced inflation that was only episodic in the world before that. And so you have to adjust your perspective, and you have to think about why are you investing? You're investing because you want to take the fruits of that investment sometime in the future and be able to live off of it or buy stuff and buy real things.

29:43And so those things are going to be affected by inflation. So that's one big important issue. I would look at inflation-adjusted returns as my metric. On the bond side, bonds are theoretically less risky than stocks, although sometimes they can be very volatile themselves. But you have to realize that bonds, you're not getting an upside. Occasionally, something will happen where interest rates suddenly go down and bond prices go up. But that's not why you're investing in bonds unless you're a short-term speculator. You're investing in bonds because they basically take your money from today, ship it into the future.

30:27And unless it's an inflation-protected security, you're getting future dollars, which are going to be affected adversely by big inflation shocks. So bonds are sensitive to potential for future inflation in the long term. And in the short term, they respond to variations in the interest rate. Now, that's easy to say in one word. It's impossible to really explain all the complexities of what goes in to causing variation in the interest rate. Today, more so than almost any time I can think of in the past, everybody's watching the Federal Reserve and the Treasury Department, they're trying to figure out what branches of the government and, or even something, Federal Reserve is not exactly a government institution, it's independent.

31:15What are those decisions that the Fed will make? And how are they going to affect my bond portfolio? And those are human beings making decisions and thinking about what effect on the economy those decisions will have. So there's a lot of speculation about what's driving them to do this, that, and the other thing. And that, in turn, makes it difficult to really forecast bond returns, at least in the short term, very well. So those are the two different ways you think about stocks and bonds. However, one of the things that stocks and bonds both share is that their promises of future cash flows. That means both stocks and bonds are affected when the interest rate goes up or down.

32:05We've seen this recently because when the stock market went down after the Federal Reserve decided to start raising interest rates, a lot of that is probably due to the discounting of the future cash flows from the stocks in the same way you discount the value of the future coupons that you get from the bonds. So the present value suddenly changes when the discount rate is raised. So 2023 kicked off with an incredible conversation with Nobel laureate Robert Merton, just an incredible guest. He was so kind. And as we shift in this year-end episode into thinking about how investors should think about their long-term decision-making, I think hearing Professor Merton's perspective on our long-term asset mix and why that is important is a great way to keep going here.

32:57So ignoring human capital, what influence do you think time horizon should have on the mix between stocks and bonds in an investor's portfolio? That's a very good question. It's a complicated question. So I'll try to break it down the way I think about it. Obviously, if you have to pay your taxes in a day or a week or a month, and the big penalties, if you don't, then you don't put that money in stocks for the week. OK, so I mean, that's just simply common sense. But if you're looking at long horizons, such as as often said that in the long run, stocks really aren't risky because there's an argument which is both mathematically and empirically incorrect, which is that if I have a very long horizon, then I'm going to earn by the law of large numbers or some argument or just looking at the data, I'm going to earn the expected return without taking risk.

33:55If I can wait 200 years, I'm going to get by the law of large numbers. That's a fallacious argument mathematically and empirically it's refutable. Okay. So what I first want to say is what's not true is that in the long run, stocks are not risky. They are. And in fact, how much money you will have at some future date gets larger if you're taking risk, the range, the farther out you go. Okay. So I just wanted to first of all, be very clear about that. By the way, I wish it were otherwise, because then we could solve all our problems in the United States. We could just tell Congress, borrow a billion dollars.

34:35Okay. Which they do all the time in the United States, put it in the whatever portfolio that some pension advisors say will earn in the long run, 6%, 8%, you give your choice, okay? Then you'll put it in there and you're eventually going to surely going to have a very big payoff far enough in the future. So, I mean, let me just use, I don't know, 8 % or something, some number like that, that they sometimes use for portfolios. If you could get 8%, what's the time horizon for a country? Let's say the United States or Canada. I hope at least a couple of hundred years. And so what does a billion dollars, if I borrow a billion dollars at 3 % and I invest it at 8%, I borrow the government rate and I invest it in this magic portfolio, how much will I have at the end of 200 years?

35:37That's a math problem, but I can give you a hint. $4.3 quadrillion. You've heard of trillions now. We throw those around. A quadrillion is a thousand times bigger than a trillion. So$4.3 quadrillion from borrowing$1 billion today and investing it in that magic portfolio. So that's a long horizon for a person. We hope it's not a long horizon for the country. So if I have 4 point something quadrillion in the bank, the government bank, like anyone who has a lot of assets, safe assets, you can go and borrow against it. So we've got 4.3. You see where I'm going. We've got quadrillions for sure. Therefore, we don't have to have any taxes.

36:28We'll just borrow for it and then pay it off at the end. and we can spend as much more or less we want. And by the way, if you're worried about 4.3 quadrillion not being enough, borrow 2 billion. Now you're up to 8.6. You see my point. The very argument you've all heard it, particularly with pension funds, that in the long run, it's really not risky. It'll all work out by some argument. If that were really true, the country has a much longer horizon than any pension fund. so it can really do the job i'm kicking you through this example because i hope it will make people say that doesn't make any sense it can't be such a free lunch and there isn't so whatever you think is there is that way so time horizon is important obviously your planning horizon and so forth and that factors in to when you solve the problem optimization but the idea that somehow if you have a long horizon, you don't have to think about it, that in the long run, you're going to get what the expected return or some other simplifying argument is fallacious.

37:36And it's dangerously fallacious in that, you know, if people really behave that way or we run our government that way, we have a serious problem. And I tried to explain it by showing this little, what Jonathan Swift would call a modest proposal that creates something that's completely ridiculous to say, if you don't see the mathematics of it, or if you don't see the whatever, you can see there's something wrong with it. It gives too much of a free lunch for all of us forever. We see that one popping up, by the way, as an aside, from time to time in the political framework where they say you can borrow forever and it'll all work out.

38:17So I don't know if that's responsive enough, but I think I'm trying to give you a sense that what is not right. Now, with Horizon, it's not simple. I may have a long planning horizon, but the horizon might not have a very big impact on what I hold in my portfolio each time, other than my risk-free asset. Obviously, the risk-free asset is going to pay me for sure when I want to be paid. If I have a very long horizon, the risk-free asset is going to be a very long, some kind of bond, whether it's inflation protected or dollars or euros or whatever. But other than that, I say the time horizon as important.

38:58And there are some characteristics such as mean reversion and so forth when you get into technical stuff where if you have a long enough horizon, you may get more benefit from it. But I just view that element as just standard portfolio optimization. All right. So great to hear from Professor Merton. We also got some really interesting insights from Professor Francisco Gomes on how asset allocation should, or to our surprise when we heard this from him, should not change over the life cycle. Can you expand on that a bit? How does optimal asset allocation change over the life cycle? So building on this, so when we're young, we still have kind of our whole trajectory of income, of wages coming up for the rest of our lives, right?

39:40So this human capital is gigantic. It's huge. It's at its maximum. We still have all our human capital ahead of us, and we haven't accumulated that much wealth. So therefore, this ratio I was just talking about is very, very large. A lot of human capital, very little financial wealth. So we can afford to take significant risk in our financial wealth because if things don't go well, we have kind of this human capital fallback on. As we get older and we start having less and less years remaining in which we're going to earn our wages. At the same time, if we're being prudent, we're saving for retirement, so our wealth is growing and growing.

40:13So this ratio is actually falling significantly because the numerator is falling and the denominator is increasing. So the ratio is just falling, falling very rapidly, which means we now should be converging to a more and more conservative portfolio. So this kind of gives rise to sort of this standard target date fund predictions or recommendations, right? If we invest in a target date fund, which these days is default option in many retirement, DC retirement plans, they have this decreasing profile. And it's kind of based on this intuition that you kind of early in life, you can afford to take more risks.

40:41As you approach retirement, you can afford to take less risk because it depleted more and more of your human capital. So you have sort of this glide path until retirement. Now, this is a good rule of thumb for retirement allocation. But of course, when we think about our whole portfolio, it has to be a bit more complicated than that. Because now we have to think about the expenditures side, we have to think about those income shocks. So early in life, you know, since I don't have much wealth, if I have an unemployment spell, or I know I have some major expenditure, or I know my car breaks down, or some major house repair, or medical bills, those can happen even early in life.

41:16If I haven't saved enough in liquid safe assets, then I might not have enough to cover those bills. So first, we want to make sure we build what is called a buffer stock of wealth. We have like a pot of wealth we can fall back on if things go bad in terms of the income side or in terms of the expenditure side. So first we want to build that buffer stock. And that buffer stock, since it has to be available there as sort of an emergency fund, it has to be invested in relatively safe assets and relatively liquid assets. And it should be about six months to a year and a half of our wealth, basically depending on how large these risks are as we accumulate more and more wealth then we should just start putting more and more in stocks because we can afford take risk and also at some point you have enough wealth this buffer stock becomes less relevant because if i have significant amount of wealth even if i lose 10 15 on the stock market you know i still have enough and if i invest in that low cost broad index fund losing more than 15 in a year in the stock market is very very rare So if I kind of follow in that trajectory, then I'm just going to be investing a lot in stocks.

42:22So if you want to think about a simple rule is if you have like a graph where you plot sort of on the horizontal axis, your age, and on the vertical axis, you have your allocation to stocks or risk assets in general, it should be kind of like a hump shape. So you start more or less moderate early in life because you want to have that buffer stock in a relatively safe asset to a large extent. Then you increase sort of towards 35, 40 years old. You kind of max out over there. and then you kind of sort of gradually decrease towards retirement. So that's kind of the standard profile or standard prediction that most of these early models would predict.

42:57More recently, I've kind of deviated a little bit from that, I must say, to the extent on the last part, you know, that glide path towards retirement. So there's a bit of dispute among academics about how much more comfortable people are in taking risks as they get richer or not. So some academics think that there's not much evidence that people become more risk lovers as they get richer. I think that by now, especially in this context, the evidence is overwhelming that they do, that people feel more comfortable taking more risk as they have more wealth. And so that kind of counteracts this idea to decrease significantly your allocation as you get older because you're becoming richer and richer.

43:39So now my recommendation is more kind of a mild decreasing path or even a flat one. So for example, myself, I'm following a flat one. I'm not decreasing my allocation and I have no plans to decrease it as I approach retirement. So that's kind of, in a broad sense, the light path of allocation over life. It's super interesting how regret forms part of how we make long-term decisions. And David Blanchett joined us for a second time in 2023 and talked about regret. And then he compared regret aversion to risk aversion. So we have two clips of David. So let's go to those. What is driving that regret in investing?

44:16This is going to shock your listeners, but people aren't utility maximizing robots across all time periods and all times. We're people, right? I mean, we go back to the tulip mania, you look at real estate bubbles, you look at like people are prone to greed, right? And when things start doing well, I think investors respond differently to having missed out. Could this have changed my life? Oh my gosh, I could have bought Bitcoin at a dollar and now it's worth, I don't know, 25 ,000, whatever it is. And so I think that the emotional response that's triggered when we see other things do well that we don't own, it's very personal, it's very emotional.

44:50But I even make the point in the research that I would say even institutional asset managers, to some extent, could suffer from regret. You could see this, for example, in the performance of the US stock market. You might hate large cap stocks as a tactical asset manager. But if you don't own them and they do really well, that could be really bad for you from a benchmarking perspective. So even if it's a little bit less efficient based upon your expectations, it could actually make sense to still own it to the extent it allows your clients to realize the value of your process through a full cycle.

45:23So to me, the key here is not just saying that, okay, you could have less wealth. You have to acknowledge that individuals bail out over certain time periods and that's where they really get burned. And so trying to do things to keep them engaged over longer time periods, acknowledging regret, acknowledging FOMO could actually help them create more wealth over the long term. I want to start on your new paper on regret, which is just a fascinating way to think about portfolio optimization. Can you talk about the difference between risk aversion and regret aversion? So risk in traditional portfolio optimization routines is like standard deviation or downside risk.

45:56It's volatility or losing money. And I think we can all kind of agree that that's pretty uniform. People don't like losing money. Now, people have different perspectives on what losing money would do to them. So like, you might be really conservative and I might be really aggressive, so I'm okay being a more aggressive portfolio. What that totally ignores though, is how you might feel about certain assets doing really well. So risk is focused on kind of like losing money, regret, or like FOMO would be like a fun word to use. It's focused on this notion that how you experience an outcome could really affect you.

46:33So maybe you didn't lose money, but maybe not making money really negatively affects you and it creates all this emotional pain. And it's obviously a different type of pain than losing money. But if you think about risk as a continuum, maybe I would have been willing to have a little bit more risk in my portfolio if it would reduce regret at some point down the line. So all these behavioral things here too, like we've seen this investors abandon diversified portfolios during speculative bubbles because they're missing out on this next wave, could allocating to assets, even in small portions, actually increase their wealth because it keeps them diversified over longer time periods because they're less prone to investing speculatively.

47:12Continuing on with the idea of regret, one of our most popular guests in 2023, it was Daniel Pink, who wrote the book, The Power of Regret. So let's hear what Daniel had to say about optimizing for future regret. Okay. So that's regrets that you have. The other thing that I liked in your book is that you don't talk about avoiding future regret, which of course makes sense because we've talked about how it's important. Can you talk about how to optimize future regret? Yeah. This is a tough one because there's a little bit of nuance here. So theoretically, what we would want to do is just is minimize future regrets, right?

47:45And that makes perfect sense. Totally makes sense. It's harder than it looks. And the reason for that is that we make a huge number of decisions. And if you're putting that kind of analysis on all your decisions, it will grind you to bits. And so what we want to do is, this is like social psychology 101. And you guys have probably talked about this too. There's a difference in the research on decision-making between what are called maximizers and what are called satisficers. maximizers want to make the best decision in every case. I want the very best ETF. I want the best roofer in Washington, DC to fix my slate.

48:25I want the juiciest hamburger in the Delmarva area for lunch. I'm going to get the best of everything. And what we know is that maximizers and satisficers say, it's good enough. I just have a hamburger. It's good enough. Whatever the hamburger is. I'll just, you know, most of these ETFs are the same. I don't really care about one basis point lower in fees. I'll deal. There are plenty of good roofers. I'll just take whatever roofer there is. Here's what we know. Maximizers are often slightly more successful. They are also miserable. Okay. They are miserable because you can't maximize on everything.

49:03And again, going to Ben, one of your earlier questions here, and I think this is the thing that's so exciting about this emotion of regret is that you pop the lid on it and inside are like these pretty fundamental questions about how to live your life. Okay. So one of them that you brought out was the difference between where do you have agency and where do you not? What's in your control and what's not? And if something's not in your control, don't stress out about it because it's futile, right? Now, in this case, the difference is this. There are some decisions on which you should maximize. There's no question about that.

49:37But most decisions you should satisfy some. And that's hard for a lot of us to do. And my view is that the optimal way of doing this is that you maximize on your avoiding these four core regrets. You maximize on avoiding the regret of not building a stable foundation. You maximize on your regret of not wasting your time on this planet and trying stuff. You maximize on being good. You maximize on building connections of love and everything else you satisfy, son. Because again, let's go to housework. If you were to have a conversation with yourself 10 years from now, the you of 10 years from now really doesn't care which hamburger you chose.

50:20The you of 10 years from now doesn't care whether you got the best roofer in Washington or the third best roofer in Washington. The U of 10 years from now doesn't care whether you bought a blue car or a gray car, right? The U of 10 years from now, though, does care about those other things a lot. And so if we maximize on those important things and satisfy some everything else, I think that that at least gives us a map, a route to a life well lived. Okay. So let's now go back to Charlie Ellis, episode 244. He had pretty clear thoughts on what the most underappreciated action that every individual investor should be doing to be more successful.

51:04You've been doing this for a long time, Charlie, and you've talked to a lot of people. What do you think is the most underappreciated action that individual investors can take to be more successful? Well, defining who they really are, figuring out what the real problem is. I'm an art history major, but I had friends who were engineers, and they all told me the same thing. Most of engineering is learning how to figure out and define the problem. Alving the problem is not very hard. And most of us, candidly, with regard to investing, have not figured out what is the problem. And we just didn't realize, oh, yeah, that's really important.

51:43And if you could get everybody to sit down and spend even a day trying to figure out what is the problem. They try to be well advantaged. All right. Continuing on this idea of decision-making, one of the challenges in personal finance is that every person is going to have different beliefs, which is ultimately going to impact their decisions. John Campbell told us how household beliefs tend to differ. You mentioned households differing in their beliefs as being one of the challenges of household finance, do you have a sense of how much households differ in their beliefs and preferences? So the evidence on beliefs is just beginning to come in now as people, but really the holy grail in the field is, can you link self-reported beliefs to what people actually do?

52:27And you're always going to have a small sample where people report their beliefs and it's hard to link to what people do, but we're beginning to learn about that. I would say there are some persistent differences in beliefs. Some people are just always more optimistic than others. It's sort of like temperament. Some people are more up, some people are more down. And then when people say their beliefs are changing, they do seem to change what they do, but only a little bit, not nearly as much as the sort of portfolio choice formulas that we discussed earlier would imply. So it's as if the beliefs are a very noisy measure of a sort of amplified measure of what they truly act upon.

53:05Now, with regard to preferences, that's another great question. And I have a working paper that studies this in Scandinavia, where we can measure quite accurately both how much households save and also how they allocate their assets. So this paper, which is written with Laurent Calvay, Francisco Gomez, and Paolo Sardini, a kind of very European author team, it's called the cross-section of household preferences. And we study Swedish households that are middle-aged and have sort of accumulated some retirement wealth. And we use a life cycle model, which sort of fits that part of life pretty well.

53:38And what we find is a great deal of variation in the rate of time preference, how impatient people are. Some people are very impatient. They save early in life. They do their retirement saving. And then other people are impatient and put it off and have a great scramble as retirement approaches. We also find a lot of variation in the responsiveness of saving to interest rates, what economists call the elasticity of intertemporal substitution. And we find a bit of variation in risk aversion, but actually less in that. And the reason is that almost all of these households in Sweden do take some risk through homeownership and equity mutual fund ownership, also by leveraging using mortgages.

54:17So most people have a sort of moderate coefficient of risk aversion somewhere between four and seven. There's some variation there, but you don't see too many people with risk aversion of one or less or 15 or more. It's not that kind of range. So it's interesting that we find so much difference, even when we're looking at these middle-aged Swedish households that have some stock market ownership. because if you looked at the full population, including the very young, the very old, people who don't have any stocks, you'd probably find even more variation. But that's for us to look at in future research.

54:54This might have been the quote of the year. This really struck me when we heard it the first time, and it's stuck with me since. Decision-making is the only purposeful way you can influence anything in your life. That's something that's pretty obvious when you think about it. It's obviously true, but it's not something that I heard said so, I don't know, explicitly before. We got that from Professor Ralph Keeney back in episode 238. Such a great conversation. I remember we talk about this in the clip coming up, but I remember texting you when I read that in the book and it's just like, wow, so clear, so good.

55:30Yeah. Yeah. Ralph, how do you describe the focus of your careers, research and your consulting work? Well, my interest has always been in decision making, but my undergraduate degree was in engineering. There were certainly no degrees in decision making and very few courses. And then I went to grad school at MIT and met one of the founders of decision analysis and negotiation analysis, Howard Rafe, who was at Harvard. And I worked with him and worked with him for his whole next 50 years and mine too. And the thing is, I realized the power of decision-making in the sense that it's the only purposeful way you can influence anything in your life, in your business, in your family, or in your country.

56:20You make the decisions and then the consequences occur. So it was very interesting to me and I like working on personal decisions and the style is exactly the same as with business decisions when I've worked on. The elements are the same. So you can learn a lot from the personal decisions to help make the bigger business decisions or governmental decisions, etc. I must say, Ralph, that quote is a quote that I read in your book. And when I read it, I shared it to Ben online. that quote that this is the only way that you can purposely influence anything in your life is by your decisions. And it kind of hit me like a ton of bricks.

56:59I just wanted to thank you for that. It was a great clarifying sentence about your book. Well, and about decision making for sake. Which brings me to my next question, which is how do you articulate the importance of thoughtful decision making? Well, partly it's important because that's the only way to influence your life and we would all like to have a better life. And that doesn't mean selfishly. A better life for an awful lot of people means contributions to the lives of others as well and to their community, certainly their family, their country. And so that's what I think is so crucial there and why it is just because of that fact, which I didn't realize when I first started working out on decisions.

57:47I figured there's many ways to influence your life, but the word purposefully is key there. You can certainly influence your life greatly by acting without thinking, and particularly if you do really stupid things once in a while. I agree with Cameron. That quote also hit me like a ton of bricks. You read it and it's like that's a big, bold statement, but it's true. There's no way around it. It's the truth. You mentioned that you've got a background in engineering. I also did my undergraduate degree in engineering, and many of our listeners are computer scientists and engineers. I think that they'll be interested in the answer to this question.

58:22Do you view good decision-making or good decisions as objective or subjective? Well, they certainly have subjective aspects, I think. So I don't view them as objective in the sense is, why bother to make a decision? It's because you care about something. Now, many of those cares could be based on all kinds of subjective things. There's not an objective. That would be I'm trying to figure out the right thing from externally for my decision. And in fact, the right thing for me to consider in my decision, like the right objectives, is what I feel is important. So I think the subjectivity is there.

59:02And it doesn't mean you can't be systematic about doing it. You want to be thoughtful and organized and set up so you can do a better job. That's what give yourself a nudge is in a sense about trying to help people with that process. So I think subjectivity would be the answer there if I have to choose one of those two. Continuing with the theme of decision making, in episode 266, Professor Cass Sunstein joined us, and he's done an enormous amount of research into decision making. So we asked him about deciding to acquire more information that would help in your decisions. And here's how he explained it.

59:43I think this next question continues off of that topic. How do people decide whether or not to obtain information that could help them make better decisions? This is maybe the most fundamental of all. I had for a number of years, I'm still in a kind of reckless research project. it's reckless in the sense that any research project you should have a hypothesis that you're testing and i've asked people in many nations now nationally representative surveys whether they want to know for example the number of calories in their food what the stock market's going to be at the end of the calendar year a lot of people don't want to know that by the way which is a startling thing whether people want to know when they're going to die whether people want to know whether they are going to get Alzheimer's, whether people want to know what their friends and family really think of them, whether they want to know that, whether they want to know if their partner is having an affair.

1:00:38So I've asked a zillion questions. And here's what seems to come from the sometimes startling results. The people care about three things. First, they care about whether the information is useful. Can they do anything with it? A number of people don't want to know whether there's calories in their food, the number of calories. There's likely to be some calories in their food. I don't want to know the number. I think that's, they think I'm going to eat what I'm going to eat. And I don't want to know that. And people, a lot of people don't want to know the side effects of medicines. I think they think the food, the medicine, if my doctor wants me to do it, or if I want to do it, it's probably fine.

1:01:18Side effects aren't going to tell me anything I need to know. And so the first thing they want to know, is it valuable? People don't want to know over the year they're going to die. Because they think, oh, what can I do with that? Nothing. Most people think. Second thing people think about is, does it make them feel sad or happy? Do they think it's going to make them have a better day or a worse day? People don't want to know things that are upsetting to hear. That's why a significant percentage of people don't want to know what their friends and family really think of them. That's pretty useful.

1:01:50But if you learn that your best friend thinks you're kind of annoying. They love you, but they think you're kind of annoying. That's not good. So people don't want to know things that make them sad or scared. And third, people have an interest in just learning things because it satisfies something like curiosity. People want to know whether Shakespeare really wrote Shakespeare's plays, even though that's not very useful. And the answer might not make them happy or sad. I really want to know whether dogs are descended from wolves and in what sense. I'm really interested in that question, but it's not particularly useful for me.

1:02:30And the answer won't make me jump for joy or break out in tears. So I think the most interesting thing about information seeking and information avoidance is the power of people's rapid assessment of whether knowing X or Y or Z is going to make their day better or worse. There's an ostrich effect where with respect to health and economic things, people don't want news that will be bad. And that can create all sorts of problems in trying to avoid the bad. You don't know about the risk, you might run into it. One of the decision inputs that people may not realize they are affected by is the design of the decision itself, which has often been architected by someone else.

1:03:17There's this hidden partner in a lot of the decisions that people make. We asked Professor Eric Johnson about this in episode 240. First off, how do you describe the hidden partner that accompanies us when we make decisions? So every time we make a decision, we don't realize it, but someone has been there before us. And that person, who I'll call the designer, because that's a simple word, has actually made a bunch of decisions about how to present that decision to us. They've decided how many options. So this ranges from maybe a parent talking to a kid about going to bed or a CEO giving direct reports, possible strategies.

1:03:57Somebody has already thought about how many options do I give somebody? What happens if they don't make a choice? What are the descriptions, the attributes of the options? There's a whole set of things that have already been chosen, decided by the designer. And in some way, the thing that's really important to realize is that will determine, at least in part, what gets chosen. So, for example, if I decide not to present an option to you, you're not likely to choose it. It's as simple as that. So the designer has a lot more influence than we, as people who make decisions, and they, as designers, appreciate.

1:04:37How significant is the effect of those design choices on the decisions that we ultimately make? In some cases, particularly when the decision is infrequent and one we're not sure of, it can be huge. I think one of the world's records is held by a study done in Switzerland with real utility customers. And they were told you can either choose the green electricity, the one that's generated by, in their case, hydro and solar, but mostly hydro, or gray or black electricity, which is made by coal. And the green is a little bit more expensive. It turns out all they did was pre-check one box. So you could make either choice, but you just had to move that check.

1:05:19And they found about a 90 % difference in what people chose. And what's interesting is you think, well, maybe the first time it works, but they fool people. Something like 85 % of people stick with that initial choice. There are lots of examples, but that's the sense of pretty few things. You don't think about your electricity choices that often. so it's going to have a bigger effect than it would be if you're talking about do I want to eat liver or not. Okay, so you can have a silent partner when you make decisions and you can decide if you're going to get more information before making a decision but what about how to decide what information you will believe and whether you should update your beliefs?

1:05:56Here's Cass Sunstein again from episode 266. Okay, so we talked about how people decide whether to seek information. How do people decide what information to believe and when to update their beliefs? To get at this, this is a frontiers issue where we know so much more than we did even 10 years ago. We need to have three concepts, one of which will be familiar. One is confirmation bias. So if people hear something that confirms their prior beliefs, like I believe my dog is healthy and barks occasionally, I'm finding that very credible, the noise you've stirred in the background. So confirmation bias means we tend to believe things that fit with our pre-existing views.

1:06:43And people just do that. And there are two ways to think about confirmation bias. I think the popular way is to think it's kind of crazy, that why wouldn't we find disconfirming information as credible, as confirming information feels a little bit self-interested. And that's part of that. But it has a little more of a foundation than that. If people told me that dropped objects don't fall, which I don't believe to be true, I won't believe that. If they told me dropped objects do fall, I feel that confirms what I believe and confirmation bias would kick in. And it's rational, given your pre-existing beliefs, to update or not, depending on how it fits with what you think.

1:07:29So there's the motivated part and then there's the rational updating part. So take that as confirmation bias. Then there's a kind of subset called motivated reasoning, which is the emotional part where people believe things that they want to believe. And that means that if you tell me something about politics or something about a politician that I really am saddened by, I might think you're biased and you don't study very hard, so you don't know that the politician I love is actually God's gift and couldn't possibly have done or said that bad thing. So motivated reasoning is a second thing. The third, the newer, is desirability bias, which suggests that we believe things that we find it desirable to believe.

1:08:19So if you tell me that actually the hair loss that I thought I had, I actually don't have, that it's an artifact of Zoom and some unflattered photographs, but I have a completely full head of hair, that's desirable to hear. Thank you for that. And I will find that particularly credible. If you tell me something like my male Labrador a retriever is not so beautiful. He's okay looking, but he's not so beautiful. I'd find that highly undesirable and I'd not want to believe it. So there's desirability bias. Now, what's really fun, I think, is confirmation bias and desirability bias, if you're with me, often will go in exactly the same direction.

1:09:03Then what confirms my beliefs, I'll find agreeable and credible, and that will be desirable, but you can pull them apart. If you think, for example, that you aren't very good at sports, but you're given information suggesting you actually are good at sports, that is disconfirming information, but it's highly desirable information. And we have some data suggesting in a horse race between desirability bias and confirmation bias. Desirability bias is secretariat, is the better horse. That is, people will believe information that they want to believe, even if it is disconfirming of what they started out believing.

1:09:49So this is a very long-winded way of saying that what people believe fits with what they find it pleasing to believe, motivated reasoning, and with what they start out believing. That can mean, one last bit, that good news will be more credible than bad news with respect to almost everything, which can lead to unrealistic optimism with respect to, let's say, investments. And it can also lead to terrible mistakes in updating. Professor James Choi joined us on episode 260. That was an incredible episode. We asked Professor Troy, why financial decisions are not always explained by economic theory.

1:10:35People do all sorts of stuff that economic theory would not predict that they would do. Why? They sure do. So James, in general, why do you think economic theory often fails to describe how real people make personal finance decisions? That's a big question. I think that every theory, every set of theories is wrong. So the statistician George Box famously said that every theory is wrong, but some are useful. And so anything that's going to have some kind of explanatory power that has some ability to offer insight is going to simplify the world. And so it's going to necessarily not get everything right.

1:11:11And the question is, how wrong or what kinds of wrong are you willing to tolerate? Because you think that the insight that's provided is reasonable for that cost. And so economic theory, just like every other theory, has its blind spots, its oversimplifications, and its particular kinds of oversimplifications that had traditionally been made over many decades in economics, that at some point we decided that the wrongness was too much to be tolerated. And so this kind of notion that everybody is perfectly rational and is able to do these complex calculations on the fly, or not necessarily on the fly, but at least eventually get there.

1:11:49That was a pretty useful paradigm to maintain the research for a very long time. And then you had people like Danny Kahneman, Amos Tversky, Richard Baylor, having a lot of fun and showing ways in which we systematically make mistakes that seem to deviate from that rational paradigm. And so that birthed the field of behavioral economics, behavioral finance. And so I think that people are not rational calculating supercomputers. They have limited amount of cognitive ability. And then there is cognitive illusion that we all suffer from to a certain extent. And then there's failures of self-control and motivation.

1:12:27And all of these things were kind of swept under the rug and ignored really for many decades. And we're still kind of in the process of figuring out what is the right balance of these other forces to allow into our theories and into our models. Again, recognizing that we need to oversimplify and get some things wrong in order to get greater insight into what might actually be going on in people's heads and in complex economic systems. Another reason that people might make errors in thinking about the future is overconfidence. And one form of overconfidence is miscalibration, where people overestimate their ability.

1:13:03They overestimate the precision of their predictions about the future, which can lead to all sorts of problems in future-oriented decision-making. We asked Professor Zahi Ben-David about this in episode 268. He's done some incredible papers on miscalibration specific to CFOs in American companies. We've got one more topic to cover to finish up our conversation here, Zahi. So you've got a couple of just phenomenal papers on this idea of miscalibration. I love these papers. Can you talk about what miscalibration is? So these papers are part of a broader literature of behavioral biases, behavioral economics.

1:13:44So in behavioral economics, we think about biases from rational thinking, and there are many different biases. But the two that we're thinking about them often in kind of either household finance or financial markets or behavior of managers, executives, as we have in this case, are optimism and overconfidence. And one way to think about these is basically these are like first and second moments in predicting future outcomes. So optimism is going to be being overly optimistic about the outcomes. Outcome may be sales of my firm next year. Overconfidence is about the distribution of outcomes. Obviously, sales next year could have a distribution that could be good, bad, or maybe in the middle.

1:14:32overconfident, I'm just too sure of my forecast. And in the literature of psychology, people think about three types of overconfidence. One is called better than the average. And this kind of matches to this survey question, are you better than the average driver? The answer is, of course, and the others are morons. And it turns out that 80 % of people think that they are better than the average. So there's one type of overconfidence. The second type of overconfidence is called illusion of control. So things happen in the world. And oftentimes we attribute these things that happen outside to our own decisions.

1:15:09So this was a great decision of me to invest in the stock market, see the stock market went up 10 % last year. Obviously, if I lost money, it's somebody else's fault, not mine. And the third one is miscalibration. Miscalibration is really an over estimation of my own ability to make forecasts. Oftentimes, people ask in the context, not in the financial context, in order to measure overconfidence, people ask a series of questions. And the goal in these questions is going to get 80 % of them correct, let's say. So this is going to be an 80 % confidence interval. So these type of questions might be, for example, what is the distribution of the New York Times?

1:15:53When was the black plate? And for each question, you would give me some range. It happened between these years and these years, the distribution of New York Times between this number and this number. And the goal of this game is to get 80 % of the answers within the range. Now, as it turns out, most people are miscalibrated. They give you a too narrow interval. They're too confident in their own estimate. So this is kind of the background. Now, you could see how this type of bias is so important in the corporate world, right? I mean, in order to advance in the ranks, you'd better be a good manager.

1:16:34Good manager, meaning taking good decisions, deciding on the right advertising campaign and closing sales. And by being bold and being confident in your estimates, you're more likely to succeed. Now, oftentimes, I mean, other people have shown in the research, past successes are attributed to people who have been advanced. I don't know whether you notice I have a slight accent, not everybody can notice it, but I'm originally from Israel. And there is this saying of, you know, who becomes the chief of staff in the military, although they took risks and were lucky not to be killed in the battlefield.

1:17:12So it's the same thing. You're a risk taker. You don't realize that you're taking risks and you happen to survive. You climb the ranks. Hal Hirschfeld was a guest twice in 2023. First time was for the launch of his new book, Your Future Self. He was also a guest at our live episode from Future Proof. So the book, Your Future Self was one of my favorite books of this year. I thought it was an incredible book. And ultimately when we make financial decisions, it will have an economic impact on our future self. But how good are we at understanding our future selves? So with you just some segments from Hal's visit on episode 256.

1:17:51How connected do people tend to feel to their, I guess, potentially changed future selves? So there's a continuum. I would say we all have a tendency to think of our future selves as if they are different people. This is an analogy, but I think to some extent, we sort of think of those future selves as if they're sort of another person, but where we differ. When you say you asked how connected are people? I think the way to answer is that some people experience a great degree of connection with their future selves, the sort of connection that we feel to our kids, if we love them, our spouses, if we love them.

1:18:31And other people experience not necessarily like a dislike, but just they lack that strong connection. The analogy that I like to use is it's the coworker of yours who's in the break room. You know, they're there. It's not like you're surprised at their existence, but you're not that emotionally invested in them. You're not that close to them. And so that's another way of describing the relationship that some people have with their future selves. Which emotion drives decisions that favor our current self over our future self? I would almost answer it a different way and to say it's not witched emotion, it's just that emotion favors our current self.

1:19:11In other words, everything that's happening right now feels more intense than the stuff that we think is going to happen in the future. It's not that it's just like greed or laziness or pleasure or any of those things. It's also Also on the negative side, I dread doing something right now and I don't want to experience that. So I push it off to later. So it's not that I would say that there's one emotion that necessarily colors their tendency to do things now versus later. It's just that we're feeling so much emotion in the present and it can lead us a bit astray. And I want to be careful there because there's a lot of times where it really makes sense to prioritize the present.

1:19:49is what's happening. And if I think about what's certain and what's not certain, I'd rather do the thing that's certain. The problem becomes when I sort of excessively prioritize the present at the disservice of my future self. What do you think it is about our future selves that makes them feel like a stranger? It's such a deep question. There's so many things involved there. One of which is that they don't yet exist. And you can think about it. There are strangers in our lives Again, I said the coworker, but it can also talk about the people all the way around the other side of the globe. They currently exist and we don't know them.

1:20:27Our future selves, they don't exist yet. It's incredibly hard to tap into their emotions. We're really not that great at forecasting our feelings into the future. if you think about it that's probably one of the four aspects of being able to relate to somebody if i can feel what they're feeling and see the world through their eyes and that is just a really difficult thing to do which i think can increasingly make it likely that our future selves are seen as strangers and then another component that needs to be mentioned here is that it's really easy to get wrapped up in the present that's where everything's happening and can make it really hard to think beyond that.

1:21:13Mayor Statman is someone we had wanted to have in the podcast for a long time. And this year we finally accomplished that. Mayor is very well known and well respected in the study of behavioral finance. And we actually got to meet him, which is pretty cool at Future Proof in California, which was really cool. We got a nice picture with him too. When he was on, one of the things that he talked about that was really impactful to us was his description of the third generation of behavioral finance and what that means for decision-making and advice. What's the third generation of behavioral finance?

1:21:47So the second generation kind of expands the domain or expands the range of behavioral finance beyond making mistakes that no longer assumes that all people want is to maximize wealth. So people want to maximize wealth, but they also want to stay true to their values. The third generation of behavioral finance really broadens the lens of finance even broader. And it says, eventually, what finance is all about is maximizing people's well-being, which is sometimes called happiness, although happiness is too narrow. So the question is, what is money for? Money is for well-being. And well-being has many domains.

1:22:38It is family. It is friends. It is work. It is health. It is religion and values. It's the society. And so I wrote a book that is called Finding Wellbeing that looks at these domains. And the important thing is that finances, money, enhances well-being. But more than that, money underlies well-being in all the other domains. You cannot support a family without money. You cannot see a doctor without money. You cannot enroll at the university without money and so on. And so some people who write about those issues of well-being and happiness say things like, what is really important is friendship.

1:23:32Well, that is nice, but friendship is not enough. And you need money even for friendship, because if you're going to go on the subway to visit the friend, you have to pay. That's a great explanation. A great friend of the podcast, Dr. Preet Banerjee joined us on episode 269. Again, another great episode. He's done some amazing research into the value of having a financial plan. Here, Preet shares with us his thoughts on that. That seems like one of the big findings from the paper is that regardless of channel and regardless of how valuable we think advice is, having a financial plan is huge on every metric that you looked at.

1:24:13Yeah, because portfolio management's commoditized now and the value add is in everything outside of the portfolios. Now, I know there's some people are still stuck in the portfolio-centric view of the universe of financial advice. Not to say it's unimportant. It's just that the relative importance of adding value on that aspect, that's a much tougher game now than it was before. Now we have all-in-one portfolio ETFs. What are they, 20 basis points now? man, that's tough. That's tough to beat. Wouldn't you rather focus your time and energy on areas where you can make a much more significant difference with probably a higher level of reliability as well?

1:24:55I mean, that seems to be the trend moving forward, but it's a slow turning ship as you know. We really do try hard. We put a lot of time and effort into providing high quality personal finance information on the internet through a podcast and through my YouTube channel free to the world. That's something that we're passionate about, but it's also something that if you look around personal finance channels on YouTube, high quality information is not so easy to find and low quality information tends to get a lot more views and a lot more clicks. So we asked Darren Soat, who is a YouTuber, a successful YouTuber with a huge channel, but also a very thoughtful guy.

1:25:40We asked him why that is. Why is it hard to find high quality personal finance information on the internet? Why is it harder for high quality personal finance information to be seen on YouTube? It's because YouTube is an entertainment first platform. It really is the house of Mr. Beast. One example I like to use is someone who is a good friend of mine and it's Patrick Boyle. If you look at his old lectures, where he might explain something like the Fama-French five-factor model, that probably doesn't get a lot of views, but it's something that's really important. Maybe not for somebody to understand about their own personal finance, but if you're trying to learn something about finance, you should probably watch that video instead of watching a day trading video.

1:26:22The issue with that is it's boring. And while it might be interesting to somebody like yourself or me, to a general audience, it's not. So basically, for his more current videos, he has to kind of be more news related. He adds a little bit of comedy, dry humor to it. And you have to do that because if you think about how Mr. Beast operates his videos, every second is trying to keep the viewer watching for a little longer. And if you're watching for a little longer, then that's more people that the video is pushed to. And if the video is being pushed to more people, that's more people that watch the video, which is ultimately more revenue for Mr.

1:27:01Beast, which is more views, which leads to more revenue and more growth for his brand and more growth to his channel. So like, you know, for example, he'll do something at the beginning where he says, you know, I'm about to throw these Lamborghinis into this grinder and crunch them up. But you'll see that at the end of the video. And then kind of in between, he'll do a bunch of other different things. And the whole idea there is to keep people to watch the video for a long period of time. With that comes the fact that you have to basically compete with clickbait. I try not to use the word clickbait, but you really have to be competitive for clicks.

1:27:35So what I try and do is I try my best to balance making sure that what I say is with the video title and thumbnail is relevant to the video. Because if I'm not competing for clicks, then I'm not going to be seen over some of these more nefarious actors on YouTube. So I have to, in a way, find ways to be creative with my title that encourages people to click through. So it's an incredibly hard thing, especially if you're a channel like mine that brings people in and says things that they don't want to hear. Like, it'll be harder for you to retire compared to prior generations. You won't get rich quick and then still get views.

1:28:11It's incredibly hard to do that, but ultimately you have to figure out how you can be competitive with others in YouTube. And it really just comes down to being entertaining because again, YouTube is really an entertainment first platform. And if you're not entertaining, then you will not make it on YouTube. In working with an advisor to help you make your long-term financial decisions, it's really important to be aware if your advisor is properly understanding you, and your situation. We welcomed Harold Geller, a lawyer who helps consumers sue financial advisors, and that was the actual title of that episode in episode 236.

1:28:49We dug into that question about whether or not your advisor is properly understanding you. I want to come back to Cameron's question, but I want to ask it slightly differently. Cameron asked about product, product due diligence, KYP. I want to ask a similar question on KYC. We were talking about risk profiling and you illustrated an education opportunity for an advisor to give to their client through that process. How should a client know whether their advisor is properly performing the KYC process, properly understanding them as a client? Well, it's also difficult. How much are they asking about your past investments?

1:29:25And it's not just what was your experience, although that's important, right? Because that's in a subjective evaluation and might inform things about your objectives and your risk tolerance. But also, what did you do? When did you do it? Did you make money? Did you lose money? How did the experience of making money impact on you? How did the experience of losing money impact on you? If I made you 10 % over two years, how would that impact you? If you lost 10%, now let's try 20%. These are the types of discussions with know your clients that really should go on. not just good news about how successful a financial advisor is.

1:30:09Also, if the financial advisor is using a whole lot of industry jargon, then you really got to question their skills. Because one of the skills is communication. And I think this is true whether you're picking lawyer or financial advisor, pick someone who can explain the concepts to you, who will help you to learn more about the industry terms so you can understand the forms, so you can understand the reporting. If your financial advisor is not sitting down with you, when you get your first statement and asking you what you understood and what you didn't understand, what more information you could use, then they're not reporting to you meaningfully.

1:30:49That's another indicator that this whole KYC process, which should be ongoing, is not occurring. And if it only occurs at the beginning or once every couple of years when they have to fill in a mandatory form, they're not really keeping up on you because we all forget. So we asked about KYC. Well, KYC changes over time. And most of us forget to tell people about KYC's changes. Know your client's circumstances to change. Well, I mean, there are obvious ones. I'm planning to retire. Well, I'm probably going to tell my financial advisor about that. But if I'm worried about getting my bonus or I'm worried that I'm taking on another expense because my child got into a university and it's going to cost me more than I planned, those are material changes.

1:31:36And if the financial advisor is not seeking to update themselves regularly about these changes by sitting down and inquiring, then you're not likely to report them. And it's a garbage in garbage out scenario. They can't give you good advice because they don't know you. All right. Continuing on thinking about the role of financial advisors, we did also ask Professor Robert Merton where he sees the role for financial advisors. You mentioned financial advisors. What role do you see for financial advisors? I see, well, obviously it depends on what they can have multiple roles, but first of all, that But financial products are complicated and they're not transparent to the holders.

1:32:19So they can, like a doctor, they can give them advice on those products and explain it to them and tell them the things that are there. I mean, that's pretty basic. They can put together plans. They can talk to people. We can get much better at it. Some are doing that by looking at the life cycle of the person and extracting from that what they need to do rather than just mechanically saying 60, 40, 70, 30, whatever. But the advisor themselves can do a huge job. And the reason is that you're not going to hire an advisor if you don't trust them. I don't think. If you trust them, they're in a position to therefore help you get to a good solution you can't get to yourself.

1:33:05So trust is an absolute essential. And that's what I see the advisor providing. As I already said, mathematical models by themselves are not trusted. Despite what they say, technology by itself is not trusted. I don't think you would take your cell phone and put in, ask, what should I do about my sore leg? And if it came back and told you, cut it off, you would do it. All right. You don't trust your technology by itself. Technology combined with things, yes. That's the role of the advisor. I say that however they do it is providing that trust the same kind of trust that you need for your medical at some point they can explain things to you at the end of the day you're going to have to trust the person is in the operating room or you're going to have to trust the person that's prescribing it because you have no other choice so I I'm sorry to run on about this but I view that the issue of trust is absolutely essential and you cannot verify most performance.

1:34:09Okay. We know that if you could, there'd only be one provider. You only have two choices, three choices, verification. Then you don't need trust because you could just do it. Transparency, which means you really understand what you're seeing. That's limited. Okay. And if you don't have transparency and you don't have verification, then you have to have trust. And I think the role of the advisor is trust. And if advisor is your advisor, they have that asset. Maybe they shouldn't, but they do. So they have your trust. And therefore, that's the important role I see for the advisor in the mechanisms.

1:34:47And I don't see it being replaced directly by someone who just claims that they have a mathematical model that does it, unless the provider is a very trusted entity. And probably that doesn't work. Okay, let's go back to Preet Banerjee again to get his perspective on the business of financial advice and how that has changed over time. Can you talk about some of the main problems with past research that's attempted to demonstrate the value of financial advice? There's a couple. I cover quite a few aspects in terms of the challenges of studying this problem, but I'll just highlight I think a couple of them that sort of come to mind right now.

1:35:25The first one is moving goalposts. Financial advice has evolved continuously and continues to evolve, and will into the future. And it's in response to competition, consumer preferences, availability of information. If you use it as an example, May 1st, 1975, pretty auspicious day in our industry, it was May Day. And that's when commissions for securities trades were deregulated. So up until that point, it was a fixed commission schedule, no matter where you went on the street. And at that time, a lot of people thought this is going to be the death of financial advice. And that didn't end up happening.

1:36:03The industry responded. Consumers sort of said, oh, great, we'll go to these discount brokerages. The industry, an attempt to respond to changing consumer preferences, changed from just providing advice on individual stock trades to, at the time, portfolio management and trying to look more holistically at all the different parts of people's portfolios. Now, that was a slow process. That did not happen overnight. And you could argue that that's still happening in the industry. So not everyone is evidence-based like you guys. So changing goal posts is one thing. Over the time you look at the history of research in this area, that's one part.

1:36:38The second, the framing of the value of financial advice has always been made in the context of the portfolio. So it's very portfolio-centric where the measures of success, the outcome measures, the dependent variables have been what's the size of the portfolio, are people getting more diversification if they use a financial advisor versus doing it themselves, things of that nature, all rooted in the portfolio. And contemporary industry practices, the market for financial advice has again shifted. And it's again, a very slow gradual shift towards non-portfolio-centric advice model. So looking at being more holistic, including things like insurance coverage, estate plans, tax planning, cash flow management, debt management, and other things other than the portfolio.

1:37:28The other sort of problems that thinking about the value advice has kind of been a very binary thing. And so a lot of the research says, here's a study looking at people who use advisors and people who don't use advisors. Now, there's a couple of problems with that. One is not all financial advisors are created equal. There's a huge variation in the quality of financial advice. Some of that is even set at the firm level. It's interesting. There's early on in the days of financial planning, when it was still kind of been delineated, there are some firms that bar the use of the word financial planning.

1:37:59Because if you said that, that might put the firm at risk of having to fulfill a fiduciary duty, and they didn't want to go down that road. and portfolio management at the same time kind of has become a little bit commoditized. So the value propositions have changed. And so there's also different channels of advice. So it's not just financial advisor or not. There's many different types of financial advice available. And then within those channels, there's different quality of advice as well. I would categorize a lot of the prior research as being very undifferentiated. And what I set out to do was take a much more differentiated look at the market for financial advice and take into account that there are some channels that might be better than other channels.

1:38:44And within each of those channels, there might be better models of those channels, again, in those silos. So previously quite undifferentiated. And then the flip side of that coin is households are also not all the same. So just as not all financial advisors or channels are the same, not every individual is the same. And you probably have great stories to tell about different types of clients. Some that are probably can't wait to have this meeting. It's going to be, you know, I enjoy talking, they get it. We're on the same page. And other where maybe you end up firing down the road because you know what, it's just not a good fit.

1:39:17And we're giving you all the advice and you're just not taking it. So households are not all the same as well. We had Victor Hagani and James White on in episode 270. And they've got this book where the premise is that there aren't as many intergenerational billionaire families as you would expect based on the wealth of people, whatever, a couple of generations ago. Their explanation is kind of the whole premise of their book. I won't spoil it, but we did ask them what explains the puzzle of the missing billionaires. Okay. We've talked about in general terms, financial decision-making is hard, especially over the long-term and people make investing mistakes.

1:39:56More specifically, what do you think explains the puzzle of the missing millionaires? Well, we face all kinds of headwinds in terms of, you know, trying to grow and maintain our wealth. I mean, there's taxes, there's the fact that we're spending our money, but we think that those sort of obvious problems don't really fully explain the puzzle at all. And so what we think is happening, and as we've taken a closer look at some particular families, we really see this, is that over time, people make poor risk decisions. So as James was saying, this has been a really, you know, the last 120 years has been a super positive investment environment.

1:40:33So it's not that returns have been really low. It's that people take either too much risk or too little risk at different times with their investment portfolio, and also with their consumption or spending decisions. So, you know, these two things go together. We're going to talk more about risk and volatility in your spending decisions and how that could help or hurt your outcomes over time. But on both the investing and the spending side, we think that people weren't making good decisions under uncertainty. And that's really what our book is primarily about, is these how much decisions, these risk decisions, you know, it's much more that than the choosing of your investments.

1:41:15Can you talk about the features of the common, but important financial decision-making problems that most people face? Sure. You know, I think that the most important common feature is uncertainty, that we just don't know what the future holds. And building uncertainty into our decisions is really important. And it's kind of subtle, you know, that you don't want to just think about what's the most likely thing to happen, and then make your decision based on that, or make your decision based on a probability of a certain outcome. You want to take account of all the outcomes and you want to have an objective function.

1:41:51You want to have a benchmark that you're using to translate all these financial outcomes into what's important for you to come up with the best decisions under uncertainty. And we'll expand on that more. What do you think are the most consequential financial errors that people commonly make? Our belief is that there are decisions around risk. And as I was saying earlier, you could be taking too much risk or too little risk over time. Also, I think that sometimes people kind of believe that you can get return without much risk. And I think that that leads people down some very bad paths that at the center of thinking about investing and your decisions that you have to really build in that there shouldn't be a way to get more return without taking more risk.

1:42:41And so I think sometimes people will take risk thinking that they're not taking risk and they're just getting kind of return for free. You know, another really big error that I think people have a tendency to make is to extrapolate the future from too little past data, you know, what we call return chasing, thinking that the future is going to be very much like the immediate past and that this extrapolation error that we are prone to making, I think, is another really harmful one over time. I would add, and this is something we see and work with clients a lot in our investment management practice, is people failing to connect their investment policies with their spending policies.

1:43:29And that lack of connection, especially not being able to withstand a lot of spending volatility, but having a lot of investment volatility is what leads to not just once, but sometimes many times for people having to de-risk when markets are on their lows, then they re-risk when they're on their highs. And they ride that several times, and that can be really wealth-destroying for people. and I think the ultimate, ultimate cause of that is people not recognizing that their spending and investing policies need to be determined jointly rather than separately. Global male personal finance writer Rob Carrick joined us again in 2023 and Rob's such a, first of all, great guy.

1:44:17We get along great and the episodes are super fun to do. Rob's got the position of having his ear to the ground for what Canadians are thinking about when it comes to personal finance by virtue of getting so much correspondence from readers of his articles. So he's on the front lines. Here's a great deal from readers. So we asked Rob about the current state of financial planning for the average Canadian on episode 272. So you mentioned value from advisors. What proportion of Canadians do you think are getting comprehensive advice from their financial advisor? So I had a JD Power survey on advisors and customer satisfaction with it.

1:44:55And I think I'm going on memory here, but I think it says something like 6 % were getting what J.D. Power set out as comprehensive financial planning and services that go beyond just managing investments. So what I take from that is that very few people are getting comprehensive. I think a lot of people were probably a little fuzzy on all this. And when they answer these surveys, I find these financial surveys give out results that I just don't believe a lot of times, like half of people can't afford$200 for a financial emergency. I mean, come on. I think the way they're worded, I think the way they're put out there, I think the way they catch people at dinner and they're not really thinking they'll say anything to make the surveyor go away.

1:45:33I don't believe half the data. And the 6 % sounds a bit low, but I don't think it's very low. I think most investors are just getting their portfolios managed. And they may get a little chat about taxes and they may get urged to open up a FHSA for their kids or that sort of thing. and maybe the advisor has systematized their contributions to all their accounts, like it's going to come out of your account, go in every month. But a financial plan, a conversation about goals, I mean, a look at states and wills and taxes and all that stuff. I think a minority are getting that, probably a very small minority.

1:46:07Where do you think the resistance, if there is resistance, is it on the consumer side not really necessarily wanting it or is it up to the industry to compel people to seek out planning advice? It's a little bit of both. I think people want it. If you said, Cameron, would you like us to do a big financial plan on you before we get to your investments? You'd say, yes, please. But the process of doing it is laborious. And I'll go have to find out numbers. And I don't know where to find them. And eventually, I'm going to lose interest and think, oh, maybe this could all just go away. I mean, I've been through it myself.

1:46:38And I was surprised at how many factoids I had to go find for the planner. And it was a bit annoying. But I was very curious about the results. So I was quite motivated. And I don't understand why people aren't more motivated. You've got to tough it out and do this. So I would put a little bit of onus on the individuals, but it's also the industry. You know, it's all about selling. It's a selling business. It's not an advice business. And it likes to pretend otherwise. It likes to pretend it's an expertise business. But really, it's about selling. It's about pulling revenue out of client portfolios.

1:47:06And the planning is kind of like, that's like your eye on you're sitting in neutral. You're not driving forward doing that. And so I think it's partly the industry. Now, the industry is making moves. I'm hearing the term planning used a lot more by people in the industry, but I'm not sure what the net effect is on people. Is there a financial plan? Have you had a conversation with a person? What's driving the investment choice? Did you just do a quick risk questionnaire and then off to the races? I think that's what's happening most of the time. And I think there's a big disconnect between what people want and need and what they're getting from the advice industry.

1:47:41I mean, my email in basket is full of questions, questions, questions, questions all the time. And I would say about four or five times out of 10, I'm sending people lists of investment advisors. These are advisor questions, planner questions. And a lot of them say, oh, thank you. I'm really open to doing that. Why are these people not already working with planners and advisors? Well, I suspect some don't have the assets or some can't find the right person. I think there's like two solitudes out there. There's the planners and advisors, and then there's the clients. And half the clients or some percentage of them are finding you and you've got good relationships and it's going well.

1:48:19And then there's a whole chunk of people who aren't matched up with advisors or planners who probably should be. And I challenge the industry to find a way to serve these people at whatever asset level they have. I mean, there's all this talk about how AI is going to change the advice business. Well, I can think of a great way. How about you figure out a way to serve people with small portfolios? To the extent that someone decides that it makes sense for them to seek out financial advice, it's not necessarily easy to pick a good one. No. Yeah. So we asked Professor Ioanni Linema, who has looked at the role of financial advisors and the impact of financial advisors on investors' decision-making, how he thinks investors can assess the quality of an advisor's beliefs.

1:49:01That's one of the things that his research has suggested is that many financial advisors have misinformed beliefs, which if you're an investor, it's not ideal for obvious reasons. I think Ioanni had some really good points and tips, but ultimately, I think his answer speaks to the challenges of picking a financial advisor, which is not an easy task, unfortunately. At the client level, how do you think investors can assess the quality of a potential advisor's beliefs? The problem is going to be that if you, as a client, you know that's the right questions, that's already going to imply that you probably wouldn't even need a financial advisor.

1:49:41So of course, we want to advise people that when you look at an advisor, pay attention to the fees that you're going to be paying. Don't try to invest in funds that are going to be churning around too much and things like that. But again, if they can be asking those questions, that already implies that maybe they would know how to do it on their own. So somehow it would have to be about education, not just about how you approach advisors, but how you tell people about the financial markets. And the issue that people have found, and this is not about our study, is that educating people about financial matters is really, really tricky.

1:50:12I think there was a study by Bruce Carlin from UCLA. In a lab, they had people do experiment where they gave people different types of credit cards, different types of fees, and then they asked people to choose the best card. What would be the cheapest option for them? And of course, people made many mistakes with the choices. And then they educated people like what would be the right choice. And when they tested the people again, after the education session, they found that people make many fewer mistakes, that it's kind of easy to teach people to do the right thing. But then they did a follow-up where they asked the same people back to the lab a few weeks later and gave exactly the same test.

1:50:47And they found that none of the advice had stuck, that people had made the same mistakes. so we can always tell people that in terms of advisors don't pay too much for mutual funds don't chase returns and probably they're going to be nodding and saying that that makes perfect sense but then when you meet with an advisor they're going to be very convincing when they say that well this can be high fee fund but the returns are going to be even higher and all the education that you have given is probably going to go out the window again the main question of well how do you educate people how to make the choices that's the big question we don't have an answer to it At the end of the year, we had a spectacular guest in Dr.

1:51:24James Grubman who authored two of our favorite books. Number one, Strangers in Paradise, phenomenal book. And then the most recent one, Wealth 3.0. The episode with Dr. Grubman is fantastic and you have to go back and listen to it if you have not listened to it yet. Anyways, we had a chance to ask James about, if you are looking for an advisor, how to identify an advisor that gets the importance of Wealth 3.0. Would you have any pragmatic advice for someone in terms of how can they identify advisors who really get the importance of Wealth 3.0? Oh, that's a good one. That's really important. Because if you're sort of a client who is ready for Wealth 3.0, you need an advisor who's thinking in 3.0 capable advisor.

1:52:13And I've talked with various firms and advisors and families. and they raise exactly this point. If you're a 3.0 family with 2.0 advisors, that's not a good fit. How do you make a change? If you're a 3.0 firm with 2.0 clients who still think wealth is toxic and it's going to fail, and they want you to do certain things about that, that's not a good fit. But if you're a 3.0 client, how do you identify a 3.0 advisor? Number one, listen, what do they ask about? What do they lead with? Do they focus on fears, negative outcomes, likely difficulties? They lead with challenges, the challenges of wealth, or do they seem to have an, remember we talked about openness.

1:53:10Advisors vary from closed to open. And I've had advisors who say, hey, I've seen sure sleep to sure sleep. It's real. Why are we not talking about that? The idea that actually we have no evidence whatsoever, no statistics that are any good of exactly what does happen with families. Families do struggle, but don't tell me you actually know how much or how often. So listen to how an advisor approaches things. Are they open to talking about communication techniques? Are they interested? Do they push products or services aimed at controlling the money for the family? Or do they show openness to family communication?

1:53:59Family meetings are probably one of the best things that can be done for a family. But a lot of advisors don't know how to do family meetings or are really nervous about them. encouraging communication within the family, giving resources that help parents talk to the next generation in ways that are useful. A 3.0 advisor emphasizes strengths more than challenges, asks, what have you already done to begin working on this? Asks, what do you think I can do to help you with it. It's a very collaborative relationship. And if you will allow me, that leads into a related area, which is collaboration among advisors.

1:54:49But I'm going to pause here for a second in case you want to pursue some of the other things first. Oh, please keep going on advisor collaboration. Well, I think one of the biggest new movements that's part of Wealth 3.0 is a rethinking of the nature of wealth management and the fact that it really needs to be collaborative and integrated among the advisors serving a family. In 2.0, and you know this better than I do, a big phrase or label that came up was the advent of the trusted advisor and that desire to be that first phone call. That's a precious position to be the center one. We talk about the quarterback, the general contractor, whatever you want to say.

1:55:41But that wonderful position of the primary advisor for the family that directs everything else, particularly at the ultra high net worth level, that just doesn't cut it anymore. The complexity of wealth and families and the desire of families to have all of their advisors play well with each other, like in kindergarten. It's a different world. The demographics are changing. And the movement is shifting from the trusted advisor to the trusted team. But for a lot of advisors, they see danger in that. It's a threat to their position. They want to be the trusted advisor. and they're not really very good at collaborating with others.

1:56:24Protecting the client relationship is more important. And so for families and clients that are ready for 3.0 approaches, one of the things to watch for is not just how does your advisor talk to you? How do they talk to your other advisors? Are they open, collaborative, willing to function as a team with accountability? or do they want to own the relationship and they're mistrustful or wary or standoffish when you ask them to work with other advisors? That's one of the most important changes that's going on. We also have to share Dr. Grumman's thoughts on what is one of the most frequent questions that we get, which is how to prepare children for wealth.

1:57:12And Dr. Grumman's answer to this question was, as you would expect, incredible. This is from, again, episode 282. What should parents be thinking about as they prepare their children to receive wealth? Ooh, that's a big question. And often asked, and I know many listeners have that question. Well, here we could probably spend two or 3 ,000 hours talking about age-appropriate education and skills training and other stuff. So that's the long answer for that. The short answer is actually, and it's funny because, again, it goes back to adapting parenting. Parenting of a seven-year-old or a nine-year-old needs to be very specific when the family has wealth compared to when you're talking about parenting a 17-year-old or a 27-year-old.

1:58:07One of the things that I often talk about is the idea that when you become wealthy, when the family becomes wealthy, money disappears, especially in the modern world. It becomes in the background. When a middle-class family uses a credit card, and then the credit card bill comes in the mail, and you have to pay bills at the end of the month or periodically and stuff, a child watches their parents having to, well, what used to be write a check, now maybe it's online or whatever. But money is present. People more often now have cash, although it is again transitioning to more electronic but kids see money in wealthy families a debit card that's linked to a brokerage account that gets automatically paid from a money market account that you manage using plastic for a purchase the kid never ever sees the money get changed hands.

1:59:12You have to explicitly reinsert cash transactions, money transactions into life so the kids, remember what I said before? So the kids can see decision-making. And so one of the things I often tell a story about how I took one of my wonderful grandchildren to the Lego store. If you've ever been to a Lego store, you know what a monumental amount of wonderfulness is in that store. And you also know what the prices are on Legos. And I did something that I've written about and others talk about. We went in and basically I was going to do a treasure hunt first. I said, we have a budget of around$100.

2:00:02going to go around and why don't we talk about what you might want to select. I'll buy you the gift. It's not your money. I will pay for it. But we're going to first look around and you're going to decide how you want to sit. I basically gave her a budget. And she said, okay. We went around and she tried this. She looked at that. Sometimes she said, well, this and this add up to 100, don't they? And I would say, yeah, you can have both if you want. And then she might do some other stuff. Well, no, that's over the limit. So first of all, I was trying to teach her how to evaluate and make decisions of what's a good value for the money that we have that we're going to spend.

2:00:45Eventually, she picked out something. And then I did something different because we could have gone up, could have given the credit card transaction. She would have taken her hand. Give me a kiss on the cheek for grandpa. And that would be it. But we didn't do that. I was prepared. I had a bunch of$20 bills. So before we went up to the counter, I gave her, I asked her, there's going to be tax. It's going to be a little bit more. So I gave her like$120 in 20s. But in her hand, we go to the counter. her. The person behind the counter takes the toy and says it's 112, 50 or whatever it was. And so she says, okay.

2:01:33And she takes the 20s in her hands and she counts out 20, 40, 60, 80, 100. And the next one, they take the money in, give her the change back and they give her the thing, she turns to me and she said the thing that was the biggest payoff for the entire exercise. She looked at me with big eyes and she said, Grandpa, that was a lot of money. I said, yes, it was, but it's okay. You're worth it. And I kissed her and everything was fine. She never would have said, that's a lot of money if I had paid for it with plastic. That's really interesting. Kids need to touch it. It's concrete. It's tangible.

2:02:21They need the contact with money as transaction in order to learn some of those skills. And of course, we have to include a segment from our episode with our good friend, Shane Parrish, who joined us to talk about his new book, Clear Thinking, a perfect final segment to this episode, and really something to consider as you think about your goals for 2024. for. How do you think people should approach determining what their true goals are? I think it should be like an annual sort of exercise, to be honest with you. I don't, you don't set out at 19 and like, here's my goal in life. And you know, it's, it's never changing.

2:02:59Here's the destination I'm going to get to. I think you just have to take stock every year with yourself and have a hard conversation. I do this, I go away. I usually go away for a night just to a different city. I want to get out either into nature or into a different city, different environment that I'm in. And I really just go for a big walk. And I start thinking about like, what are the things that I like doing this year? What are the things I didn't like doing this year? How can I do more of the things I liked, less of the things I didn't like? Am I moving in the right direction? Am I going at the right pace?

2:03:30Can I sustain this? If I get to where I'm going, do I want to be there? Is it worth it? Because we only get one shot at this thing we call life. And if we spend all of our time on things that aren't important to us or things that are important to somebody else, then all of a sudden we get to the destination and we're like, oh, why am I here? And if you look at, Carl Pilmer wrote this book called Lessons for the Living. And what he did, I thought this was a genius idea. He went to a whole bunch of people who were close to death and he asked them, what would you teach us about life? And the number one regret was they didn't live a life true to themselves.

2:04:08In Warren Buffett's words, they played by somebody else's scoreboard. And so we have to set our own scoreboard and make sure that we're aware of where we're going and we're getting the things that we want. And those things are worth wanting. And that's our look at 2023. It's really hard to pick the segments to make our storyboard at the end of the year, but that's our attempt this year. Once again, we're super grateful for all of our listeners and viewers, of course, and everyone who reached out by email or left a review or said hi to us in public, which happened a couple of times, not that often, but it did happen a couple of times, which is kind of neat.

2:04:42So of course we wish everyone a great holiday season and hope you kick off 2024 in fantastic fashion. Yep. Well said.

2:04:57Thank you.