How to Make an Effective Financial Decision

Gary Belsky July 7, 2016

Douglas Goldstein: I am very happy to have on The Goldstein On Gelt Show, Gary Belsky, who is the former editor in chief of ESPN The Magazine. He wrote a fantastic book - probably the first book that really brought to the public the idea of behavioral finance - called Why Smart People Make Big Money Mistakes And How To Correct Them. Gary Belsky, a real pleasure to have you.

Gary Belsky: A pleasure to be on, thank you.

Book Title

Douglas Goldstein: Your title is, Why Smart People Make Big Money Mistakes. Do less smart people also make big money mistakes?

Gary Belsky: Everybody makes big money mistakes. Originally the working title was Why Smart People Make Dumb Money Mistakes, but the publisher thought that would be a little bit off-putting. What we know from the field of behavioral economics and behavioral finance is that the biases and mental blind spots that people bring to decision making - in all aspects of life - are especially obvious and democratic, when it comes to money decisions. The smartest investors in the world, and the least experienced investors in the world, or insurance buyers, or shoppers, or whatever the case may be, are all prone to mistakes or inconsistencies in the way that they go through life and make decisions.

Douglas Goldstein: The second part of the title is, How to Correct Them. On the show, we’ve discussed a number of behavioral finance issues that people have. There’s always a good story, and they are fascinating. I want to assume that everyone knows either themselves or someone who’s just done something that seems really stupid afterwards. How can you train someone not to do it if it’s natural to make behavioral finance mistakes?

Gary Belsky: They’re natural mistakes because they are actually parts of our brains that evolve to solve different problems and make different judgments. On the savannah, or in jungles, or in the desert, the human brain has been around for hundreds of thousands of years. For most of that time, nobody ever had to decide about buying insurance, whether or not to stay in law school, or how to invest in the stock market. The mistakes we make aren’t irrational; they’re just a function of obsolescence. A lot of the decisions we come up with are because they would have made sense in a different time, in a resource-scarce society.

Reprogramming Your Mind

Now, how to reprogram yourself? It’s very difficult by the way. There’s so much more insight into why people do the dumb things they do with money, than there is into how they stop doing it. My biggest piece of advice involves two things; writing down the decisions that you make, whether or not it’s investing or your thought processes. What people often do is they tend to forget the things that were wrong and they over-emphasize the things they did that turned out well. There’s a woman named Ellen Langer, a professor at Harvard, who calls it, ‘heads I win, tails it’s a chance.’ We only remember the things we do well and forget the things we do poorly. However, we often learn the best mistakes from the things we do poorly.

The second thing is to discuss financial decision-making, investment and insurance decisions, with somebody else who doesn’t have a stake in the game. That’s simply because while everybody has a whole suite of biases and blind spots in their heads that leads them to making dumb decisions, very few of us have the same suite in our heads. Oftentimes, the easiest way to poke holes at a decision or at a potential decision is to not be involved with it. It’s much better to hear somebody else explain why it is that the thing that you’re saying is not making sense.

I came from a background in personal finance at Money Magazine. Money Magazine was built in America on the belief that everybody can handle their own finances themselves; you don’t really need financial advisors. It’s not worth the money. But when my dad died, for example, I recommended that my mom get her own financial advisor, even for one or two percent a year in asset management fees. What the manager does is provide counter balance to your own biases. Write things down so that you have a record of what you thought first. Talk to somebody that you trust about the decisions that you have.

If you don’t want to do that, because some people are very private and prideful about their financial decision-making, I often recommend that you simply make the counter argument to yourself. When I’m thinking of doing something, I just make the counter argument like, “I’m going to do this, but before I do this, I’m going to have to argue against myself.” That often ends up giving people a feeling in their gut when the counter argument is strong and it makes them nervous. That’s often a sign that maybe your supposition, your original thinking, is a little bit off.

Douglas Goldstein: I agree. When you’re about to make a decision, just stop and wait. Nothing that you do, in almost every case, requires an instant decision. If you’re dealing with a pushy salesman who’s pushing you into some investment, saying “No, no. You’ve got to decide now,” that’s definitely a red light. You need to walk away. Like you’re saying, in making a counter argument yourself, give yourself space from the decision that could start by just waiving a little bit.

Writing Your Thoughts Down

When you talk about writing things down, what exactly should people be writing down? How does someone who’s putting together a financial plan or deciding on some investments write that down?

Gary Belsky: They need to write down the first principles; the things that are important to them and the conclusions about what they need to do. When you write it down, it makes you really think, “Oh wait a second, I wrote that because I was anxious, or because I was hungry yesterday, or because I just heard a story about somebody who lost all their money on the stock market. My idea is that I want safety and I need to be in the bond market.” And you might probably realize later that the idea didn’t make sense.

Trust Your Instincts

The other thing people need to do is to trust their instincts, for example, about buying a certain stock. They probably thought about buying Wal-Mart because it’s got a lot of stores and they’re really doing well. And it turns out that now, they might have thought that in the same day they thought about Apple. But three years later, when they’re thinking about where Apple’s price is and how they missed an opportunity, they also don’t realize that they missed an opportunity to buy a stock that didn’t do nearly as well.

If you look at people’s ideas, roughly half of them will be good and half of them will be bad. This is why so many people are probably best advised to invest in passive index funds, etc. It doesn’t mean that you can’t do better than the stock market, but one has to be honest with oneself about one’s own judgment and one’s own record. In general, when I have investing ideas, I try to write them down. When I go back later because I’m feeling bummed about a particular thing that I didn’t do, I’m also like, “Oh I didn’t do that either, and that would have worked out poorly, so maybe everything’s okay.”

Choosing Your Financial Advisor

Douglas Goldstein: People conveniently forget a lot of information. You talked about the concept of talking to someone else in order to make a decision. One of the things that I’ve seen as a financial advisor is that people will often talk to their friends or family members, but they end up receiving the worst advice. When you talk about talking to someone, is it anyone in particular or a financial advisor who actually knows what he’s talking about?

Gary Belsky: On the one hand, you want to talk to people who know you; talk about your thought process. They will probably say, “You tend to be anxious about these things, but it’s probably a good idea to take a bigger view.” They know you personally. This person might just point out the patterns in your thinking that are not necessarily in your best interest.

They often don’t know anything more about investing, insurance or annuities, unlike a financial advisor. If the financial advisor has a track record and a system that seems to suggest that he or she can have a business relationship with you, he is going to make more money off of you in the right way and give you good advice for a long time. Those people are always the best people to talk to because they have knowledge of the financial world that most people do not. They are able to recognize what really matters and what really doesn’t.

People should talk to someone who is trying to inform you and give you a basic understanding of what they are thinking, so that you can make smart ‘yes or no’ decisions based off of that. A trustworthy professional that will give you, if not unbiased advice, a kind of opportunity to understand who you are, where you are and what you want, in a cost efficient and flexible way.

Douglas Goldstein: When you get a financial advisor who is asking about you and understanding your situation, that's a good sign, as opposed to someone who’s trying to sell you something. A number of times I’ve heard, usually a woman, come in and I’d say, “Who’s advising you?” She says, “Well my ex-husband is suggesting that I do this.” That goes against the whole trust idea.

Gary Belsky: You could make the kind of argument that the ex-husband wants the ex to be financially independent. One might hope that their interests are aligned. People need to understand that much of investing is complex, but there are some basic principles. A lot of it is dependent on who the investor is and what their goals and risk tolerance are.

The Nosy Financial Advisor

Gary Belsky: I always tell people to look for nosy financial advisors. The best financial advisors are nosy because they understand that financial strategy is actually a function of who the person is. There is no blanket advice for people, and part of it is about, “What are you going to do when the market crashes?” If you’re a person who’s going to panic when the market crashes, then I have to keep you in a slightly more conservative, less stock-heavy portfolio. You’re going to be happy that the market’s down 20%, but your portfolio’s only down 15% because you weren’t that much in stocks to begin with. That will make you feel better and stay the course.

A good financial advisor will understand the psychology of the person they’re dealing with and use that as a way to create a portfolio; an approach that is rational because it recognizes the irrationality of people.

Douglas Goldstein: When I started this company 20 years ago, I ended up calling it, “Profile Investment Services.” Had I met you back then, I would have called it, “Nosy Financial Advisors.” Just all the branding and marketing we could have done would have been so much better.

Gary Belsky: You seem to be okay though.

Douglas Goldstein: How can people learn more about you, the work that you’re doing, and your books?

Gary Belsky: I’m an irregular columnist for money.com, and by irregular I mean that I write when either they want me to attack a subject or I have something in particular that I want to focus on. You can just search my name, Gary Belsky on money.com, and you’ll find a lot of pieces that I’ve done either by myself or with the co-author of my book, Tom Gilovich. They should buy our book, which is in 14 different languages, including English, but not Hebrew. The book is called Why Smart People Make Big Money Mistakes-And How To Correct Them and you can get it on Amazon, Barnes &Noble, anywhere you buy books.

We wrote it specifically for people who are interested in the subject but who don’t necessarily have a lot of background. It will make you smarter, but also it’s also pretty accessible and fun. The research in behavioral economics and behavioral finance is some of the most interesting research in social finances. We give advice in every chapter about how you might actually put yourself in the best position to enjoy your money and your resources over the course of your life.

Douglas Goldstein: We will put a link to all of that at the show notes of today’s show at GoldsteinonGelt.com.