How your emotions might be hurting your investment outcomes, with Dr. Joanne Yoong, Senior Economist at the University of Southern California and Freddy Lim, Co-founder and CIO at StashAway

Episode summary

Dr. Yoong and Freddy Lim talk about why people make decisions that hurt their investment outcomes.


Episode transcript

Philipp: Welcome to another episode of, In Your Best Interest, your personal finance podcast. I’m your host Philipp Muedder, and today we will be chatting about the field of behavioural finance. One of the many reasons we started the podcast was to bring you insights to managing personal finances.

Today, we will cover how investors can identify patterns in their behaviour that might be detrimental to their goals. And use those insights to make better financial decisions. For this, I have two phenomenal guests on the show. One is the CIO and co-founder of StashAway, Freddy Lim, and the other is Dr. Joanne Yoong.

Dr. Yoong is an applied economist working at the intersection of behavioural economics and health and financial decision making for the well-being of vulnerable populations. Dr. Yoong’s primary appointment is a Senior Economist at the University of Southern California, where she directs the offices of the USC Centre of Economic and Social Research in Singapore and Washington, DC.

And she's also a principal member of the USC Behavioral Economics Studio. Based in Singapore, Dr. Yoong also holds faculty appointments at the Yong Loo Lin School of Medicine at the National University of Singapore, [02:00] The London School of Hygiene and Tropical Medicine, Singapore Management University, and the RAND Corporation. She's the author of over 70 peer-reviewed articles in leading economics, medical, and public health journals.

In addition to her academic work, Dr. Yoong is the founder of Research for Impact, a Singapore-based social enterprise working to make behavioural and social science research accessible, inclusive, and transformative for everyone. Dr. Yoong received a PhD in Economics at Stanford University as an FSI Starr Foundation Fellow after an early career in financial services. And her AB Summa Cum Laude in Economics in Applied and Computational Mathematics from Princeton University. Thank you both so much for being here today, impressive resume, Dr. Yoong.

Joanne: Thank you.

Philipp: Very impressive resume. And before we get started on the topic, Joanne, we always like to ask our first-time guests some personal questions. So I’ll leave Freddy on the side for a little bit longer, just to get to know you a bit better and for the audience to find out a little bit more.

And we usually start by going back a little bit in life and see where did you grow up? Like what kind of shaped you to receiving a PhD in economics? And what was that like growing up for you?

Joanne: Yes, thanks so much for having me. So, I was born quite a number of years ago in Malaysia, and I grew up actually in Kuala Lumpur in a family of three sisters. My parents were both physicians, and we were the kind of Chinese family where everyone is actually a physician. And if you're very artistic, maybe you could be a lawyer. And so from a very early age, I think I grew up thinking to myself, what actually is it about people's behaviour and what is about people's choices that shape the way that we see the world, and how we progress in the world? I enjoyed reading; I enjoyed thinking about the way that interactions sort of happened in the world around me. But I would say that at that point in time, I had no real concept of what it meant to work [04:00] in financial services or behavioural science. It was a very traditional, if you will, childhood with a very traditional set of outcomes that we were all headed towards.

What changed my own life is that, I actually came to Singapore to do my high school education at the age of 15, and I decided at that time to sort of start exploring a little bit more of the arts and the humanities. And so I made the transition from science to arts. And here was very fortunate to have a great, I think, experience in what we call the humanities programme, with a number of really exciting classmates. And more importantly, I worked with a group of teachers who told me at the time that I could aspire to go overseas. And so it was very interesting for me because, again, I was on a very traditional track.

I had a very one-track mind about what I could do and what I could achieve, and it looked just like everything else in my family. My father, my mother, my grandma, my grandpa, my sister, my brother-in-law, all going into medicine. So at that time, sort of, I began sort of thinking, oh well, in actual fact, it's really interesting, because the division between science and arts is not so rigid.

And in actual fact, drawing on different disciplines is actually something that I could do. And one of the areas where I thought, in actual fact, I see science and art coming together very cleanly in a very interesting way is economics.

And so I managed to go overseas, again with the support of people in my immediate social network. And I graduated from Princeton quite long ago, in economics and applied math. Because I still had that Asian feeling that if you don't do math, the world will end.

Philipp: Yes. And that's interesting, actually, because Freddy almost had kind of the same background. Born in Malaysia, came also here for high school.

Freddy: You worry about the jobs prospect, right? So the math thing comes in handy.

Philipp: Yes.

Joanne: Right. And you know to do economics and mathematics coming from a background which is very medical, it's sort of a raging liberal education as it was. And so I got my [06:00] first job at Goldman Sachs and Company, and I worked in the fixed income division.

Philipp: Was that in the US?

Joanne: In the US. Yes. In New York, I worked in New York. I was privileged enough to also go to London, and then come back to New York and end up working in credit derivatives. And it was very exciting for me, again, coming from my household background, because my mother is like what is this? Are you, a teller? The concept of investment banking again for my family was very strange. So for me, it was all new and exciting, and I was able to work in a nice group and credit derivatives research with a lot of very cerebral and intelligent physics PhDs. People who were designing extremely complex projects, products for very unique markets in the reinsurance and insurance world. And at the same time, I could see just below on the trading floor that heights of exciting and irrational personal behaviour, like, every day. And it was incredible, I enjoyed my time at Goldman tremendously. And what caused me to shift my perception was basically September 11.

On September 11, I was on my way to work; as usual, being Malaysian, I was a little bit late, and I was stuck on the subway for several hours. And when I came out, the world had transformed. And I thought about my priorities, and I thought about what I wanted to do. And as I said, even though I had a wonderful experience at Goldman, I thought what I really like to do is sort of try to understand finance from a more human perspective and not have sort of a small midlife crisis right there. And I did my PhD in development economics to think about finance.

And at that time, working in the social sector, it became clear to me that the behaviour that we wanted to see on Wall Street did not actually, in my experience, follow the theories that I was seeing when I was an undergraduate. And the experiences of what I had seen in the social sector, people with very good intentions, was also not following any of the theories that I read about and tried to implement in my PhD. And at that moment in time, [08:00] again, this was far enough back that behavioural economics was not a standard part of the curriculum. It became very clear to me that these traditional economic models that I had been studying now for about ten years, both as an undergraduate and graduate student, really had something very wrong with them. And that both people who are very sophisticated in the financial world, but also people who are very well-meaning in the social service world were not getting things right. Not because they did not want to do the best thing for others and themselves, but because these traditional models were falling short in very fundamental ways. And that really has set my research trajectory ever since.

Philipp: Yes, super interesting background, I think. And you explain perfectly how you navigate around, and not everything is always a straight line, right?

Joanne: No.

Philipp: Absolutely not. So with your first job, though, and I have to ask, we always ask every guest. What did you spend it on?

Joanne: What did I spend my first bonus on?

Philipp: The paycheck, first paycheck.

Joanne: Oh, my first paycheck, like my signing bonus, came before my paycheck.

Philipp: Oh, there you go, signing bonus, too.

Joanne: What did I spend it on? I put it right into my savings account; I was not very imaginative.

Philipp: Yes, very good answer.

Joanne: Then I bought a suit.

Freddy: That's the best answer I’ve heard so far; you don't spend it. You reinvest it.

Philipp: That's correct.

Freddy: The suit is reinvestment.

Philipp: Exactly right as well, yes. Good, thank you so much for setting the stage here. And I think that this really brings us to the topic, right? And I think behavioural finance, I always thought, was a super interesting topic. The company I worked for before, Fischer Investments, Ken Fischer, is very big on behavioural finance. And trying to understand it better to be a better investor, make better decisions for clients. And also, understanding the client’s background, right? When they come calling and wanting to liquidate portfolios at the worst possible time, right? So with that being said, maybe you can give us a little bit of a background of, do you know how behavioural finance became a field even? [10:00] And kind of like what it encompasses more from a high level before we go deeper into each one of those topics?

Joanne: Right. So behavioural finance, I think, and if I even take a step back, right? To think about behavioural economics in general as a field is really sort of the evolution I think of economic thinking, to take into account these insights that we have from behavioural science, cognitive science, and psychology. And where I think it really actually sort of melts the two things together is that it takes sort of the traditional economic frameworks that we have about choice and decision making, about preferences information and constraint optimisation. And tries to marry that very systematically with the insights that we have, from how people actually make decisions.

And so, for example, what it does is if we think about people's preferences over time, instead of assuming that we have an exponential time discount factor the way that we might see in a cash flow model or an accounting model. It really tries to ask us from the point of view of what we know from cognitive science, and in fact, the actual physical structures of the brain. How do people really think about time? And what we begin to understand from that is that, in fact, people's preferences are hyperbolic. When we think about the present day, we have a much stronger tendency towards impatience than we do when we think about the long term. Simply because we think about it with a different part of the brain. When we marry this insight, which you see in behavioural science, to the economic models that we have, then we have new financial models that actually do better at first of all predicting behaviour in a more systematic way, and actually are more robust.

And so it's not simply saying we have these insights about how people behave, but actually sort of incorporating them together with traditional economic models and making them more robust, more predictive, more useful. It's about saying that we are acknowledging that we have irrationalities and deviations. But not in an unsystematic random way. So, trying to make sense of the world in a more holistic and complete manner. [12:00] And so that's, I think, the evolution of behavioural finance; we've seen this happen at the household finance level. In the last 10 to 15 years, we've also seen behavioural corporate finance. We've had researchers like Ulrike Malmendier trying to incorporate these insights into corporate behaviour at a higher level.

Not just in the financial markets and investor behaviour itself. So, I think it's a very natural evolution of the kind of work we had seen before, looking at a phenomenon like acid bubbles and herd behaviour. But really trying to strengthen this with core learning from other disciplines.

Philipp: Yes, I absolutely agree. And I think that there was a really good introduction to behavioural finance, what it is now. You mentioned earlier on that you got interested in it when you were working at Goldman Sachs, right? You were looking down at the trading floor, and it was craziness, right? Freddy, you've been on a trading floor. You worked at different investment banking jobs. How do you, well, first of all, have you ever thought much about behavioural finance? And then also, what was your experience being on the trading floor? Can you see her point of view when she was looking down, and they're like, hey, what's going on there?

Freddy: First of all, I feel like I’m the lab rat because back then, I’m on a trading floor; I don't think about it. Like someone like Joanne looking down on us, thinking about the rats, how are they behaving? So, good way to go, Joanne. No, back then, the classic economic theories were rational expectations. And there was a scene; I think if I put the time back, late 90s, we're talking about all the latest development in the 80s right with a lag. And rational expectations like the heavy heaters like Thomas Sargent, and the likes. And they are really big on model elegance, mathematical elegance, no-arbitrage, and everybody makes optimised decisions, right?

That's what they assume, and that was mainstream. Nobody talks about irrational behaviour as part of the model, right? [14:00] And so for Joanne to sort of be ahead of the times and just sort of look ahead, I think that's very progressive. But that was not mainstream back then. It's easy to say today; it's not easy back then.

Joanne: Yes, that's exactly right.

Freddy: So, that's me looking back.

Philipp: Because now it's becoming almost quite normal to, every investment bank or like trading floor probably has someone looking at this and helping people understand their decision better, and like as models to safeguard certain things, right?

Joanne: Well, yes. And in fact, I think Steve Wendel from Morningstar, which has also been a large sort of practice figure in the field, has actually been spearheading a survey now which shows that there are over 80, I think, and growing number of behavioural science units not just in the financial services but really everywhere.

Philipp: Yes.

Freddy: I mean, there are hedge funds companies that started getting experts into the firm and observing the behaviour of employees. And trying to understand people's behaviour biases. And behaviour biases are as we bring it back to investments, behaviour biases day-to-day we've seen it everywhere, every single day of our life at StashAway.

Philipp: Yes, we absolutely do. Before, I actually want to get into the question of how can the understanding of behavioural finance help people achieve their long-term investing goals? And you already said short-term versus long-term; there's some difference between this, right? Let's go first or backwards and explain actually some biases that are out there, that people might have heard of, right? That might potentially hurt them; what can they do about each one of those, right? So I think one of the big ones, of course, is also pretty popular in every country is the home country bias, right? You get it all the time. Hey, why don't I have, first time, when I look at portfolios of people? They come. Hey, can you do a portfolio review? It doesn't matter which country you're from. In that country, you will be overweight to your home country, right? German people will have 70-80% Germany, right? [16:00] US has almost close to 100% usually US holdings, right? Same here. Always ask about Singapore-heavy portfolios, right? If you're from Singapore, because you think you know these companies, right?

Joanne: Yes.

Philipp: So can you both maybe give your two cents on home country bias, and what do you suggest people do about that?

Joanne: Yes. I think there are many reasons why we actually see home country bias, right? First of all, people have very limited attention. So they sort of focus on what they know; it's quite natural for them. The other reason, I think, is that people have a little bit of an endowment effect when they feel that something belongs to them or they have some sense of ownership. Then they tend to feel that right there's a little bit more value there than something that they don't know. Sometimes there are halo effects, where because people think that they feel very strongly about the country in one regard, that this somehow spills over to other sort of things that are not necessarily related. Sometimes people feel a little overconfident because they feel overconfident, over-optimistic about things that are close to them or that they identify with.

And so for all of these reasons, we actually see home country bias quite strongly not just in finance, but in all kinds of other settings as well. And part of what is actually very important is that for people to understand or have a systematic way to overcome this or to be offered other options as a matter of course. And not to allow people to simply default into a portfolio because that's what they know and feel comfortable with.

Freddy: Man, I guess there's also a fear of having currency risk. And that the fear is not well understood, right? Because anything non-Singapore dollars, for example, people would think of it as oh, it's risky, I should always be at home. What I didn't know is...

Philipp: That's how you pay, right?

Freddy: Yes. But what people did not think about is, hey, maybe some currencies are safe haven. And if I have some of them, and in very bad times for markets, it actually reduces my risk. [18:00] And in SGD terms, my return actually would be more enhanced with a systemic market meltdown.

We've seen it during COVID, US Dollar, Japanese Yen, Swiss Franc they outperformed, even the Sing Dollar. We've seen it in the 2008 financial crisis, every time it happens. So people just need to sort of, I don't know, this is a tough one because we view it as a way to reduce risk in the extreme.

But most people are brought up to think of currency as a speculative component, as something to be feared of as something to get rid of, right? So, in this case, I wouldn't say because of your surroundings, but it's also because of your upbringing and how you have been educated over the years. That's one angle to add to Joanne’s angle.

Philipp: And for the investor, what do you suggest they should do? Let's say they have a big portfolio, right? And like a portfolio and like 75+% is probably...

Freddy: They should always be very diversified. But you need to think about having a sufficient amount of funding and safe-haven currencies in your portfolio. Because these are the one that gives you portfolio insurance when times are tough. And you also need to know where your country stands. If you're in Brazil or some emerging countries, your country belongs to a more aggressive currency. When times are bad, you're going to suffer. But when you have enough Yen, Franc, and Dollars, it does help you back home. But Singapore is sort of in the middle; it's a high-end currency, right? But it's not all the way up there like the Yen and Swiss Franc. So you're just going to know where your country stands in terms of its market status and then make an adjustment for that, right?

Philipp: Yes, oh, absolutely. And another one that Joanne brought up before the podcast, actually, one of her favourite ones, is actually loss aversion bias, right? You want to go ahead and maybe explain that a little bit. And also then we can go through the same kind of steps of how to take action and get rid of it.

Joanne: Sure. So loss aversion is a little bit [20:00] related to sort of the fundamental work of prospect theory; some of you may have heard that term. But sort of, at a high level, all it means basically is that when we experience, say, a gain, we don't get as much utility out of an equivalent gain as we lose, if we lose an equivalent amount of money. So we feel losses several times more than we experienced joy from a gain. And so we're much more sensitive to loss, and part of that, at an extreme, is partly because also at the end of the day, what that does for us is that it makes us more risk-averse when we think about losing or when in fact, losses are framed to us in a more salient way than our gains. So, when we are more aware of the losses, or when things are couched to us in “lost” terms, and so that has several implications for us. It means that, for example, when the market is very volatile, people are very likely to sell off very quickly. But when we have a market recovery, because it's going to take investors much more time to recover confidence. So, the market needs to go up and up and up before people come back in.

And then what that means is that we tend to panic sell, and then we wait too long, and we're not able to recover any of that going up if we rely on our instincts. The other problem that happens with loss aversion is that it manifests in many other ways as well. So we are very regret averse, sometimes when we look into the future, the prospect of future gains means that future losses make us very risk-averse. Some people have what we call zero-risk buyers; they don't want to take an action in the future if they can envision any loss.

So it distorts their risk preferences. It also means that occasionally when we've already incurred losses, we're very wedded to those losses in the past, so we're tied to our sunk costs. All we can think about is the cost that we've already incurred, and we're very concerned about that

And so, in general, I think loss aversion, because we have this asymmetric treatment of wins and losses. It means that when we truly face a portfolio, especially in a period of high volatility, [22:00] it becomes really difficult for us to manage that objectively.

Philipp: Yes. And I think this is one of my favourite ones because it can really destroy your financial plans, right? Or if you take this back to personal finance, right? Loss aversion is something that can really destroy all you're working for, all your life, right?

If you get out at the wrong time, you don't get back in at the right time, even though you should have maybe just stayed in the market, right? So Freddy, you and I we talk about this a lot on our YouTube channel as well, right? But it has to be said again because I think this is where people make or break their retirement sometimes, right? And it's sad to see, but it is like you said it comes from a quite scientific standpoint why it happens, it happens. But what can people do?

Freddy: I mean, hit the nails here. Because if you talk to those people, they will always tell you they want to buy low, sell high. But in reality, completely the opposite. Because of the loss aversion and things. And sometimes, one loss aversion led to a memory or trauma, and they will never get back to the market. Can you imagine when you cut at a low, and the market bounces back? There's no way the same person is going to get into the market again. And we've seen that in the 2008 crisis, and in the 10-year bull run after, a lot of people just never got back in. And that's a lot of opportunity costs for not sticking to your investment plans, right? I think that behaviour bias can be addressed with a solid plan. Where you first, before you invest, you plan the right amount of cash that you should have, right? So that you don't sell your portfolio on the low because you need the money. So that is not a perfect solution. But it sort of reduces your tendencies to sell on the low, right? [24:00] And two, maybe it's a StashAway thing, but we tend to talk about stress-testing rather than backtesting. So we tend to like to look at stress scenarios and look at historically most painful scenarios. And say, well, this is actually your risk estimates from us. And as long as this number is realistic for a crisis, that's when it matters, right? When a crisis happens, is when those risk numbers really need to be holding. But most financial models make it worse because it's just based on some arbitrary window, based on some time period that's good times. You always underestimated the true risk of your investments. We prefer to take the stress-testing approach where, and then at least you know, in 2008 happens or when COVID-19 market rout happens again, you're mentally prepared right away for a much bigger loss.

And you ask yourself before you invest, is that the right amount of risk for me? If it's not, face a reality, face a fact, reduce your risk level, right? So, those are mitigation techniques, but they're not solutions; they're not perfect solutions.

Philipp: But there are some solutions here given. From a scientific standpoint, then Joanne, is there anything that you add on how you can manage this better?

Joanne: No, I would add to that, that that's absolutely right. So we talk about some of the commitment devices, right? And having people sort of focus on the long term. We also talk about not helping people to sort of not follow the day-to-day fluctuation of the market, but really focus on periodic updates. So that at the end of the day, they don't feel that volatility. They have a long-term goal; they stick to it. And they have a strategy, and they stick to it. So to think about the strategy and not to be swayed by the day-to-day outcome, particularly in volatile markets, I think those are all very sensible things to do.

Freddy: And unfortunately, we're in an age of apps and real-time updates, right? So it goes down the edge in this case.

Philipp: Absolutely. And I want to get actually into social media [26:00] a little bit later, but we're getting there soon, but that makes perfect sense. You already mentioned sunk cost earlier; there's something called a sunk cost fallacy. Would you like to explain that a little bit more?

Joanne: Yes. So the sunk cost fallacy basically, it basically means that what has happened is that we have invested something in the past or we've put something in the past. And even though it doesn't affect the prospective outcome going forward, we are committed to that part because we consider the cost that we've already spent. And what that means is that people find it very hard to cut their losses and move on. And they also feel that a course of action that they've invested a lot of time in, or a lot of effort, and all of energy in it, they just want to see it through. So, if you ask people even right, you have a project that is almost done.

If you tell them that it's 90% done but sure to fail, they're much more likely to say, well, I just want to finish this off, right? Then, if not. And it's not just financial cost; it's emotional cost as well. Time costs, emotional costs, people feel committed to a path of action, because of the past, rather than objectively, prospectively looking at the cost of benefits going forward. So people really get trapped into a course of action because of what's happened before.

Freddy: They fell in love with a particular investment. And it's easy to fall into that, right? You spend a lot of time researching a particular company's disruptive technologies or Bitcoin or blockchain, well, what have you. You get married to the idea that this is profound. But what's often hard for the investors to decipher is how much of what you have researched is already in the information contained by the prices in the markets. And are you really taking a forward-looking approach where you have an edge, right? But without going to that direction, I would say it's because you have put in so much work and effort, and perhaps you're holding on to it. [28:00] You probably wouldn't take losses as quickly as you should have, you get married to it, and you stay longer into a losing investment. So that we see happens all the time. I don't know if that resonates to the same concept.

Joanne: No, absolutely. And the more you spend, the more you've invested in it, the more all else equal, the more committed you are to giving it another chance, and that's very tragic because it's hard for people to be forward-looking as you say, even in the face of all the evidence.

Philipp: Yes. Especially like Freddy mentioned, being married to a stock or an ETF that you bought that might have sounded good at the time, but now it's deep in the red. So for people, it's easier to say, hey, I’ll sell it when it's back to breakeven, right?  Than actually selling it at a loss because of exactly that reason. So, we see this quite a bit, so if the market is down at the point when customers see it's green again or back to zero, they're like, oh, now I can sell because now oh, I made it through, right? I made it. Oh now, I’m back to, I haven't lost anything.

Joanne: No, exactly. And then, they have this arbitrary fixation point, which is the purchase price. And so everything is measured relative to the loss that's taken compared to the purchase price.

Freddy: And in the end, the result being you're taking all those volatile swings, and just to break even and you want to get out. You have enough mental trauma, and you want to get out. So this is the other; this is one of the cases. There are some other cases when they're down quickly, they just cut their losses all the time, and they miss the rebound. There's one case that we talked about earlier, but this case is more sunk in, you get committed, right? So both cases can happen to people in different situations.

Philipp: Oh, absolutely. The other one, before I had some questions outside of the different biases, is the recency bias. I think that's a great one to understand for investors, especially if it goes both ways since you have a recent event that happened, and you're fixating on this, [30:00] or you get away. I think 2008 happened for a lot of people; younger people kind of remember but not really by now, right? So everyone says, oh nothing can happen to us, so this year was a kind of a wake-up call for everyone, especially the March period, right? Joanne, do you want to explain a little bit about recency bias and how you see from a scientific point of view?

Joanne: Yes. So I’ll talk just basically; I mean, I think it all comes back to the idea of limited attention. There's only a limited amount of information that at any one time we can keep in our working memory, really. So the amount of attention that we have for something complex or complicated. Number one inherently, is limited by our cognitive capacity. So we have number one a bandwidth constraint. Number two, what stays with us is also fairly determined by a number of factors. So what we know is that you experience the world, but what stays with you or stays in your, what we call your crystallised sort of intelligence, is really what either emotionally resonates with you or really just something in a very recent window. And so we can have as an individual or even as a community a long collective experience, but what actually stays with us in our actual tangible memory and that we act on is actually a very limited amount of information. And so the recency bias means that if only events that are very salient, very recent or very, some also exacerbated by things like the emotionality of it, the vividness of it, the specificity of it. Our ability to identify it with our immediate surroundings, all of these things combined together make an event more memorable and disproportionately affects our decision making. So not just the time dimension, but some of these other dimensions as well.

Freddy: Well, if you take a huge pain in the markets and it's recent, maybe it tends to take you a lot of time before you dare to get back to the market again, right? So we see that a lot. But it's also the other way, where people felt like they did some research [32:00] and into all sorts of fancy tech names, for example, right? And it worked. And they have this recency bias as well where I’m a great investor well, wow, I’m a great stock picker. I can do this all day long, and they started becoming a little complacent, so that's the other situation, right? And a lot of people don't question their performance versus the market. So, how much of the return you're getting purely from your stock picking skills? Or is it from the market going up in general anyway? How many percent of it is truly attributed to your work?

Joanne: Yes. And this is something we call fundamental attribution error, right? When something goes up very positively, I tend to take that information and attribute it to myself. But if things start going really bad, then suddenly it's the market, right? And if I do really well, I’m amazing, and if others do really well, they are so lucky. So, what that means is that we all rewrite our history, and we rewrite luck as skill when it's going in our way. And we rewrite our incompetence as bad luck when it's going in the other direction.

Philipp: Oh, absolutely. And one of the things that actually just came to my mind while you were speaking about that bias right now, is the other one that's very interesting is the confirmation bias, right? Because I think all of us look for confirmation, it's not just investments, right? In general, in life, you always look for confirmation. Am I doing something correctly, right?

You always look for people to tell yes, you are right. And for investing and for your long-term investments, it's quite dangerous, right? Because if you only look for, especially social media today or like any kind of news is instant. If you search for something in a certain way, you will get that information, right?

Joanne: You will find it.

Philipp: Yes. So how do people deal with this nowadays? This confirmation bias, you get what you ask for. How can people sort through this, to not upset their [34:00] personal finances and their personal financial plan?

Joanne: Yes. So this, I think, is actually very challenging at an individual level. I think this is something where in actual fact, the onus actually is on sources of information and trust to sort of create these sources that people believe in.

Because I think as an individual, it's actually very difficult for us to sort of ask ourselves these questions. And so the creation of trusted information providers and entrusted intermediaries is going to take huge prominence, yes.

Freddy: Yes, I mean in the age of social trading platforms, or people sharing their trade tips, and they have a huge following. And I find that particularly dangerous because you're sort of leaving the responsibility of your investment to someone else now. You're following them blindly because you feel attached to them. But the right thing is too, I mean, I think the professional investors are trained differently, and it took years of training, right? I mean, in my case, our seniors used to always tell us before you talk to anyone or read anything, you got to do your own analysis. If it's data-driven, the better it is. But you're going to do your analysis before you are ready to go and accept outside information. And also, when you get out there, you can't just be seeking confirmation. You got to look for differences in opinions and risk analysis that you're not thinking about outside the box thinking. But that's really tough; it takes so many years of training and discipline for anyone in the profession to even get there, right? So, in the retail space, it is made worse by social media, social trading platforms, and followings.

Joanne: Yes, I completely agree. I think there's a couple of other biases [36:00] here that I think it makes it very challenging for the retail investor. One is that we like consistency, so we like for a narrative to be consistent. So when we don't know much about something, we think, oh, it makes sense. And we don't think is it true? But we think it doesn't make sense. So if it all hangs together in a way that's consistent, we like to go with that. The other thing is that we like simple narratives. So if someone can tell you a simple story that seems to make sense, against a marketplace that's complex, conflicting, and to which they're actually true unknowables, that's going to appeal to you very strongly. And the second thing is that your perception of risk is again very driven by these, by availability bias. So if you can think of something very easily, you're going to think that that's something that's more likely to happen. So when you're on social media, it doesn't matter if someone's giving you great objective market advice that's driven by data, statistics, and charts.

But if you see that your friend's, uncle's, brother-in-law has now made a killing on something, right? I don't know what. Has managed to buy some bizarre stock in some days and has made X number of months returned in a short time. That's going to resonate on some primal level much more strongly with you than these things that you don't relate to, and you can't think about easily. You're going to think that the likelihood of that is much higher because that information is very easily available to you.

Freddy: I also think that sort of forms peer pressure, where it sort of creates a bit of a FOMO,l fear of missing out, right? If everybody you know or the platform you follow people are making a killing in certain things and you are not in the game, you sort of felt left out. And that's precisely the worst situation because, by the time you get in on belated information, you're probably the last few people in the room to do so. And hence, it does hurt you later on.

Philipp: No. I think this is a very important topic, I think nowadays. Because people know that I’m in the financial world, [38:00] and we do personal finances. Friends, family from all over the place, they always come to me and say hey, look, I found one of my friends he's doing currency trading, and he has some kind of system, and it never loses, right? You always make them. But it's happening, right? Especially like over the last year, I think it's coming up. It was the Bitcoin thing for a few years, then a year of nothing, and now it's starting to come back with like the social trading platforms. Like a Robinhood, it's easy to get in, right? It's easy to, and they show you all these nice graphs, right? And everyone is buying Tesla, right? Everyone is buying certain things.

Joanne: Yes, and you've got all the kids on Tik-Tok.

Philipp: Well, exactly right. But I’m always amazed that actually, these people can give advice because Freddy and myself have to be licensed and regulated. We have to do a continuing education, right? And if we say something wrong at a seminar, we get in trouble. But I think this needs to be a little bit more probably over time, regulated because everyone can give advice now right on what to buy.

Joanne: No, that's right. And I would say that at the end of the day, I want to make a pitch for just sort of good old investment education and financial literacy, and also mathematics. I mean, some of these are core skills that I think people go out into the world without these very core skills, and at the end of the day, you can't nudge away the fact that someone doesn't understand mathematics; it's very challenging.

So we really have to do both things. We have to think about these core skills, and think about the way that we're sort of, what are we teaching in economics courses, what are we teaching with personal finance courses. So that people have some understanding of at least what they don't understand.

Philipp: No, absolutely. But what would you say then to people like I just had friends asking, right? Look, my friend is making killing; he's been doing currency trading. He has some kind of bot or something that tells him when to buy and sell, and they never lose. Because I always try to tell them, hey look, first of all, do some research, probably it's not true, and he will have losses as well, right? There's no free lunch. [40:00] Otherwise, everyone would do it, that's what I always tell. But like you said, it's a primal instinct, people see like money, and it's easy money, right? But easy money always comes with dangers; that's what I believe in. Because ultimately, you see it's something happening. But how do you, but both of you, like how can people tackle that problem? Because I think it's like you said it's so prominent. You follow a few people on Twitter; you follow a few people on these trading platforms, right?

Joanne: No. You know, ever since I stopped working in investment banking, everyone in my family is like, you obviously make poor financial decisions, no one asks me these questions anymore. But I would say exactly that response is that if it's too good to be true, it probably is too good to be true.

Freddy: Well, you know, I think investors just need to ask certain basic questions, right? Like how long has the other side been operating? Do you have a track record? And can you show me account statements? Oh, then you start realising like the catch is out, oh this is only the last three months you started, oh the rest are backtests. And you gotta start thinking, and then you start asking questions about how do you manage risk, and you're going to start being interested in what you invest in, and ask the right questions, right? And at least the basics like where's the money held. Is it in a safe place like a bank or custodian bank, or is it with some unreliable places? And don't even get into any schemes where the custody of the money is unclear, right? So I think investors really have to just step back and ask the absolute basic questions. We owe it to ourselves.

Philipp: No, absolutely, so yes. Interesting topic, because it's just trending this year for sure, with all the people like thinking this is driving up tech stocks, right? Or like Tesla, and it was very polarising, so thank you both for giving your two cents on this.

Freddy: Rubber glove company Malaysia, or vaccines companies next?

Philipp: Yes, exactly what's next, right? [42:00] But there's always a next. So I think people just need to peel back the onion a little bit, right? And understand a little bit more what they're getting into and not always believe just the wins. There are also losses most people have throughout the years.

Joanne: Yes. I think there's also this, the problem I think is that we've also managed to sort of tell people at the same time that finance is very complex. But we also have to give this message that there are basic questions and basic things that everyone can know and understand. And at least feel in control of some basic strategies and basic information. So, on the one hand, I think we have done a little bit of a disservice to people by making them feel that finance is so overwhelming, so challenging, so difficult, no pattern, nothing.

Freddy: Jargonised.

Joanne: Jargonised. And so people are turned away from it, and then they again seek simplicity, they seek the people that they can understand and relate to. And that can lead actually to very challenging circumstances. So we ourselves, I think, as an industry, have sort of done this.

Philipp: Yes, absolutely. And there are two more questions I want to get to; the first one, is there some behavioural biases between men and women when it comes to investing? And we have both men and women here today, and I wanted to hear from you a little bit. Is there some? And if they are, can we learn from each other?

Freddy: Wait a minute. I do have some biased opinions here. Because I do believe that, according to my years of observation now, the trading floor used to be dominated by men, okay. And I’ve seen how hormonal imbalance leads to bad decisions. And I am telling you today, in my personal opinion, women make better chief investment officers than men, period.

Philipp: Right, we have to switch at StashAway then. But at least the first stage is actually recognising that, right? So it's actually a good first step here.

Joanne: And I would say that part of the problem is that we used to have such little representation that we [44:00] couldn't do statistical studies. Because we didn't have enough male and female traders to make comparisons between, so I want to say that gender is a very challenging construct obviously, and it's also socially mediated in many careers. So that's the academic disclaimer that must always be said. But what we do see is differences in economic behaviour between men and women.

We've seen traditionally that in studies in the past that women tend to be a little bit more risk-averse, number one. They tend to be slightly less over-confident. So in some of the studies that we've seen of risk-taking, that women tend to be less overconfident and therefore tend to be when they manage their portfolios, I think we've seen in a large study, I believe from Fidelity if I’m not mistaken, that men tend to trade more frequently. And as a result, sometimes, in that case, if they don't pay attention to fees, women who hold steady at the end of the day do better with their portfolios because they hold steady. We've also seen in other studies, I think again not in finance, but in other fields like medicine, where we see that men are, and I say this with great love. More prone to things like decision fatigue.

So women physicians, actually when we look at physicians in emergency rooms, we see that actually male doctors, when they come in, do very well when they start the shift, but then there's a very sharp gradient of decline. Whereas women doctors come in, and it's a straight line, they just perform straight. So there's a little bit more of an endurance to it. And I will also say that if you follow long-distance endurance running, we're actually starting to see that women perform well in long-distance endurance feats.

Freddy: I personally think this is the most critical bit of being an investment professional; it's a marathon. You require consistent decision making over time, and that's why I maintain that a lot of women make better investment decisions. I mean, we do find them harder to get, like when you pitch to women investors, [46:00] they don't get excited as fast. It's harder to get them to do anything.

But we tend to find that once they have studied the problem, and they commit to a plan, they are persistent, and they are consistent; they stick to the financial plans. Whereas men, sorry if I’m biased, but disclaimer. A lot of people I know who are men, they can deviate from their financial plans quite a bit. And find some new love in security or another company, they would just jump into it.

Philipp: Oh, absolutely. I think I saw this as well when you have personal finance clients, when I was back in the US and was managing family’s monies, right? It was the best thing you can do is actually get the wife on your side because this is the harder sell. But she will make sure that the personal finances are stick to every month, right? It's a budget. We're investing every month, right? We're not buying this stock that I don't even know about, right? So I think I saw that first had there.

Joanne: Yes. So there's I think, I mean apart from the actual equipment, I think there are, I think, very reputable studies looking at testosterone and what that does for trading behaviour. I think, however, for women, what we do acknowledge is that in the population, we see lower levels of financial literacy for women, especially in societies where women are not so exposed to the financial markets. We do have a lot of under confidence on the part of women. Maybe you could say it's overconfidence on the part of men, but we also see under-confidence on the part of women, which makes them unnecessarily risk-averse sometimes. We see that in situations, and I know we're all now in the COVID-19 pandemic, in very unequal societies, what we see is that women are carrying a lot of mental load from other tasks. And so when it comes to focusing on the long term, what we know is that when we are in a situation of cognitive scarcity when there's a lot of other things going on in the mind. It's hard to think for the long term.

And so, a woman in these situations may not be as able to focus or think about the long term, and indeed when we see [48:00] surveys of financial behaviour, lots and lots of women say that they manage the day-to-day budget of the household. They're perfectly good in terms of making decisions over financial products. But when it comes to long-term financial planning, very often, for whatever reason, that's the man's sphere. There are actually many reasons there, in addition to sort of the basic biological makeup, but sociological reasons and sort of expectations oriented reasons that create some of these differences for women in investing. And I think growing women as an investment community is something that I’m actually very passionate about.

Philipp: No, that's great. And I think there were some really good points on this. And I think now, hopefully, if you listen to us as a family or you're in a relationship, I think sharing and talking about personal finance is very important. And finding out who does what best is also great, right? So. you can use the best of both sides to achieve your goals. So to wrap it up then, I wanted to ask my last question. I have to prime the listeners so that we are recording this on the 20th of October, so we're still pre-election in the US, right? And a lot of people at this time and day are quite not worried, well some, a lot of them are worried. But it's a lot of like change about to happen, right? Either way. People are worried about the Trump election; people are also worried about Joe Biden being elected. And this is globally, right? This is very polarising right now. So my question is, what should we do or not do when the market is at a high, right? It is right now. But people think about these outcomes, and you can make a case for both of them not being good for stock markets. So what do you say people should do?

Freddy: I don't know if I’m going to answer in the right stylistic manner. But I would take an approach of analysing each election outcome, but there are four outcomes here, right? It's not about who wins the presidency, [50:00] but it's about how many chambers of the Congress each party gets. And then what the main policies would come into effect, right? And it's such a bipolar election where the two parties have markedly different stances on a lot of key policies. So, in particular, I mean, I’m sure I’m not answering this in the right style. But as a professional investor, it's more about analysing each scenario and see what's the biggest risk of my portfolio. It's not about trying to predict the outcome or to make a return because I am able to forecast the outcome. I think that is a very complex exercise.

But you do need to be aware of which outcome would have the most risky impact on your portfolio. And so, to give an example from my perspective, I see a Democratic sweep of both chambers of the house under the Congress will result in more antitrust, more stringent measures antitrust behaviour on big tech firms. And a lot of Democrats are even proposing to break up big tech firms like Facebook, right?

So you know that some volatility, bigger volatility, are coming for big tech company stocks if this happens. But this is not something you can predict is sure to happen; it's just a probability thing. But however, you've got to step in and say, hey, am I making too many concentrated investments. Is my portfolio having too many tech names? And should I consider more ways to diversify my risk, right? So it's more from that perspective. I would analyse it coldly, objectively, look at the risk, and just make an adjustment. But not in the anticipation of making a return, based on my ability to predict these outcomes, right? It's all about risk to me.

Philipp: And Joanne for you, if we take it back to the more scientific level, right? [52:00] What do you suggest people to, how do you keep in check? Because it's emotional, right? It's like I said polarising, no one knows what's happening. You can't trust the polls, as we know through Brexit and the last election. So, how do people stay calm in this?

Joanne: Well, I think firstly that exactly as you say, this is a very emotional time for everyone. I think I would echo what Freddy said, which is that this is the time to realise that any emotional time is not the right time to actually be making huge decisions about your portfolio. And to try to be as calm and objective as possible when thinking about your investments. And try to divorce this from your emotionally subjective feelings. I mean, no matter what, large groups of people, one is going to feel that this was not fair, that this was the wrong thing. So a lot of the subjective, ethical, moral, political feelings are going to be present in a large group of people no matter what, no matter what happens. So taking a step back, number one, being objective. Number two, and then also acknowledging that you need that space. I think a lot of what we know now is that a lot of the world, as Freddy said, we don't want to sort of place too much weight on our ability to forecast because we understand that that's not possible. Same way for behavioural scientists, we can't give people very specific advice about conditions. It's just not possible, and it's not responsible for us to do that. But what we can do to people is just remind them, first of all, be aware of yourself. Second of all, give yourself time, give yourself space. I can't tell you exactly what the right decision is going to be, but I can tell you that you will need to calm down and take a breath. And that's I think the only thing that we can say for certain is that you will need to take a breath.

Philipp: Yes, great advice. So even if you might be listening to this...

Freddy: But just to really pin it down. Diversification, diversification, diversification.

Philipp: That's good advice as well.

Joanne: Absolutely.

Philipp: So one builds on to the next, right? And I thank you both for being here today; I think this was super insightful. I know listeners always ask about how to be better investors, and I think we gave them some great tips on how to do this. With that being said, Joanne, thank you so much for being here today, and Freddy, same for you.

Joanne: Thank you.

Freddy: A pleasure.

Philipp: And we will be back with you in a few weeks; thank you so much.

Joanne: Thank you for having me.

[End of Recorded Material]

Episode notes

How do your emotions, biases, and decisions hurt your investment decisions? In this episode, Dr Yoong and Freddy Lim talk about the decisions people make that hurt their investment outcomes, and what to be aware of so that you can make better financial decisions.

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Episode contributors

  • Philipp Muedder (Head of Financial Planning at StashAway)
  • Freddy Lim (Co-founder and CIO at StashAway)
  • Dr. Joanne Yoong (Senior Economist at the University of Southern California)