Behaviour Finance with Brian Portnoy | E104
Understanding how human emotion impacts decision making.
On today's episode, Jason Pereira is going to talk to Brian Portnoy, Founder of Shaping Wealth and author of three books, including the must-read advisor book - The Geometry of Wealth. Brian is a well-known expert in the field of behavioral finance, and he will talk about what behavioral finance is and how it affects our decision-making and our relationships with the people advising us.
Episode Highlights:
01:22: Brian has spent the last 25 years or so in the financial services industry and started with the investment side like selection fund analysis, portfolio construction, and evaluating complex investments mostly in the hedge fund industry. But about 10-12 years ago, became fascinated by behavioral science, specifically behavioral finance, i.e., the psychology of money and have gone on to publish 3 books in that space.
04:14: Behavioral finance embraces the messiness of who we are, and it says we are not necessarily rational human beings. We show up at the table with a whole set of biases and perspectives, and our brains work in quirky ways because our brains evolve not to make good money decisions, but to survive and then to some extent, to thrive, says Brian.
06:17: As per Brian when it comes to making personal financial decisions, people often try to answer the question how much is enough versus how I get more and enough tends to be built around a story that you tell around your life.
07:16: We think of ourselves as kind of thoughtful, critical thinkers. But the fact is that the main elements of the brain are designed or evolved to basically regulate all the different biological or physical systems inside of us, says Brian.
08:44: Brian says that they know from modern psychological studies that when you give people too much, they get overwhelmed, they get stressed, they get anxious, and that's known as the paradox of choice.
09:19: We see good financial planners enter their practices in day-to-day is dealing with people as who they are, as opposed to who in economics textbook said they should be, says Brian.
10:23: When reading about behavioral finance, Jason has learned that its neurochemistry and just energy affect the way we think. Because as example, if you are thinking about something that you already know, or the more you do something, the less energy your brain expands.
10:51: The brain is wired for scarcity. Scarcity of energy, scarcity of resources, and it's not surprising that we oftentimes reach for too much without understanding how much is enough, says Jason.
11.21: Brian says that their brain is a gas guzzler, and it soaks up a ton of energy. It doesn't want to work that hard because we are constantly trying to be efficient, and in the way we use energy, it produces specific outcomes, especially in the context of our decision-making that are quite consequential.
12:34: The brain tends to seek out information that merely aligns to what we were thinking before, says Brian.
13:20: Brian says that they have something called availability bias, meaning that you tend to pay attention to something that's more in front of you, whether it be on the Internet or the newspaper or TV, or the people that you hang out with versus going out and finding new sources of information.
14:41: Jason has read in multiple places that the brain, when under stress performs worse and our IQ gets dumber when we are under prolonged stress and our ability to process information just diminishes.
19:00: In North America, there are different organizations that teach behavioral finance. They basically create curricula that force financial advisors to memorize a bunch of biases and the idea is, if you could diagnose your client appropriately, then you can find ways to fix them.
19.50: We need to stop pathologizing normal human behavior and just work with the people who show up in all their messiness and complexity, says Brian.
21:27: Brian explains what they are doing with Shaping Wealth and how they are trying to move beyond that general construct of just understanding dump of information checklists.
23:01: Brian says that they ask their learners or clients, or students like to what extent are you responsible for your client's financial well-being, and then they also ask a follow-up to what extent are you responsible for your client's happiness, and that gets people kind of shifting and they see a little bit uncomfortable.
23:44: There is a whole science of happiness that can be folded into modern financial planning that hasn't been done to date, and we are doing that, says Brian.
24:29: Each of us is born with a certain level of emotional intelligence, just like we have a certain IQ, and emotional intelligence is just not a trait that we're born with, it's a skill.
24:41: The superpower of the modern advisor is empathy, and empathy is not the ability to walk in somebody else's shows. It understands the emotions that somebody is feeling in their own place and being able to help articulate that and walk alongside them in what they are going through, says Brian.
30:32: There are studies that show that if we look at one picture of a starving child, we feel empathy. But if we find out there are a million starving children suddenly it's just an overwhelming thing and we can't connect with the crowd, says Jason.
3 Key Points:
There is a whole stack of evolutionary remnants that are built inside of us that really do not map to the traditional economic man model.
One of the unsung tasks of modern behavioral finance is that advisors get to know themselves as well or better than they are getting to know their clients and stop acting like some diagnostic expert.
Positive psychology is a distinct field of psychology and the science of happiness. It's basically saying what are the inputs to a life well lived.
Tweetable Quotes:
"Behavioral finance is basically a science and a discipline that sits at the intersection of economics and psychology." - Brian
"We know we can be emotional, but how is it human beings basically do not optimize for utility as traditional finances because there was always a very classist view to traditional finance and traditional finance goes back to Victorian era and the description was the rational economic." - Jason
"One of the key assumptions in traditional economics is that more is better, and from an empirical point of view, that's not the way we are wired." – Brian
"I feel that the modern advisor wears 2 hats or plays two roles, mechanic and guide, and as a mechanic or as a technical expert in planning in investments, taxes, estates, insurance, all the things it's important and non-negotiable." - Brian
"If someone is coming to you because they think that you can pick investments better than the next guy, I think you have a competitive problem. But if they think that you are better at structuring the estate just perfectly, it's hard to distinguish yourself on those sorts of things." - Brian
Resources Mentioned:
Full Transcript:
Producer: Welcome to the Financial Planning for Canadian Business Owners podcast. You will hear about industry insights with award-winning financial planner and entrepreneur, Jason Pereira. Through the interviews with different experts with their stories and advice, you will learn how you can navigate the challenges of being an entrepreneur, plan for success, and make the most of your business and life. And now, your host, Jason Pereira.
Jason Pereira: Hello and welcome. Today on the show, I have Brian Portnoy, founder of Shaping Wealth, an author of three books, including the must read advisor book, The Geometry of Wealth. Brian is a well-known expert in the field of behavioural finance, and I brought him on this show today specifically to talk about what behavioural finance is and how it affects our decision making and our relationships with the people advising us. And with that, here's my interview with Brian. Brian, thank you so much for taking the time.
Brian Portnoy: Good to be here.
Jason Pereira: So, uh, Brian Portnoy, tell us a little bit about yourself.
Brian Portnoy: Sure. I am a husband to Tracy, I'm a father to Ben, Zach, and Sarah. I guess I can throw my dog, Freddy, in the mix. I consider myself his dad as well. We live in the city of Chicago, about a mile west of Wrigley Field, and I've spent the last 25 years or so in the financial services industry. At the start, on the investment side of things, investment selection, fund analysis, portfolio construction, mostly in the hedge fund industry, so evaluating complex investments. But then, about 10, 12 years ago, I became fascinated by behavioural science, specifically, behavioural finance, i.e., the psychology of money, and have gone on to publish three books in that space, and the main book that, uh, you've referenced, The Geometry of Wealth, is the impetus for a company that I started a couple of years ago called Shaping Wealth, which is a coaching and content platform, uh, training financial advisors in the psychology of financial planning.
Jason Pereira: I mentioned Shaping Wealth just because it is, I think, probably like the best of them, although I have read, I'm still one book behind. I gotta get back to, I still gotta get that last one from you. One quick observation about your, your description of yourself, which I do love, is the fact that you went family, community, job. You're, you're a man who has got his priority stack set up. I will, I will tell you that much. That, that, that was very indicative of, I think, the, the conscious thinking you do around your life. So, all right, let's talk about the topic at hand, and that is behavioural science and behavioural finance. Can you explain to the layperson what these, what this arena is?
Brian Portnoy: Sure. And there's a lot of jargon that is, to some extent, inescapable. That's just the nature of things. But when we talk about behavioural finance, let, let's just anchor on, on that term. And I mentioned in a quick breath a moment ago that we can also refer to it as the psychology of money. Behavioral finance is basically a science and a discipline that sits at the intersection of economics and psychology. The very short background is that there were two Israeli psychologists in the 1970s who were interested in human decision making, and they looked at the American economics profession, and they said those guys don't know what the hell they're talking about when it comes to how people actually operate in the world. Those guys were named Danny Kahneman and Amos Tversky, and they did a lot of the pioneering work in so-called behavioural finance. The gentleman who sort of bridged the gap from those two, from those two guys into America was a University of Chicago professor named Richard Thaler. All of these people at some point went on to win a Nobel Prize in the economic sciences focused on behavioural finance. And basically, it boils down to how do human beings make decisions about money, for better or for worse, and as opposed to a very traditional economic model of the way people work, in terms of maximizing utility and having full information and a lot of other assumptions that economists make about how people work, behavioural finance embraces the messiness of who we are. Some people embrace more messiness than others, but it basically says hey, we're, we're not necessarily rational human beings. We show up at the table with a whole set of biases and perspectives, and our brains work in really quirky ways, because our brains evolved not to make good money decisions, but to survive, and then, to some extent, to thrive, and so here we are.
Jason Pereira: So lots to unpack there. I would say, um, for anyone who wants to familiarize themselves with the journey of the, the foundation of this, Michael Lewis's book, The Undoing Project, which is specifically about the partnership of, uh, Kahneman and Tversky, has been a great read, uh, both, and of course, there's been books and papers published by them, and of course, also by Richard Thaler. All fantastic. Now, before we get to dive a little deeper into this, I wanna contrast what you just said to, or expand upon the definition of traditional finance. And traditional finance goes back to, I would say, the Victorian era, if not a little bit before that, and you think about where the concepts and structures of what exist there, there was, to me, there was always a very classist view to this, right? It was like, the description was the rational economic man, so first off, no surprise that the, you know, the classist would say like, no, no, no, of course, the well-educated, or wealthy to do, we make rational decisions, when in reality, like, we're, like you said, we're messy creatures, right? So traditional finance, which worries about making the math work, which is great, doesn't always jive with people's gray matter and emotions. So, okay, so let's talk about basically, what are some of the key learnings around that concept, like, again, how does, how is it that human beings, I mean, we know we can be emotional, how is it that human beings basically do not optimize for utility as traditional finance has told us?
Brian Portnoy: Yeah, you know, one of the key assumptions in traditional economics is that more is better, and just from an empirical point of view, that's not the way that we are wired. I mean, it's not that economist don't understand, and I'll give you some jargon, diminishing marginal utility. Yes, they understand that perfectly well. But when it comes to making personal financial decisions, we're often trying to answer the question how much is enough, versus how do I get more. And enough tends to be built around a story that you tell around your life, not in some loosy-goosy, weird way, but we really are storytellers before we are, we are calculators. And so, traditional economics really doesn't have a lot to say about the way many of us make sort of regular, just, you know, economic or financial decisions in, in our day-to-day life. Stepping back, I mean, there's gonna, there's a lot of different ways that we could go here. First of all, we have to appreciate kind of how we got here. And, you know, through the lens of our evolutionary chain, and, and evolutionary psychology, the human brain in it's very first function, is here to just help us survive. Like, it helps us right, it regulates the body. Like the brain is not for thinking. We think of ourselves as kind of thoughtful, critical, critical thinkers, but the fact is that the main elements of the brain are designed or evolved to basically regulate all of the different biological or physical systems inside of us. And it's only on top of that, after that's been solved for, that we can then move on to the, the decision making part. But the kind of residue of that prioritization is that, what I call the evolutionary two step, is that we are built to survive and then thrive. So so much of the way we approach the world, and within that, make financial decisions, it's, it's really about answering the question am I gonna be okay. How do I say safe. And that has nothing to do with this concept of rationality or irrationality. In fact, at, at Shaping Wealth, we sort of have a, a loose rule that we are not allowed to use the words rational or irrational. We just talk about the word normal. Like what does it mean to be a normal human being, and if you wanna make it sound fancier, you can talk about us being adaptive. And so when you give somebody in this survive and thrive mode more, it doesn't necessarily produce great things. So for example, there's something known as the paradox of choice. This is that when you give somebody, hey, I want more things in life. I want liberty. I want freedom. I want, I wanna go to a big box store and have a thousand different things on the shelves that I can, that I can choose, that sounds pretty good. Well, we know from modern psychological studies that when you give people too much, they get overwhelmed, they get stressed, they get anxious. And that's known as the paradox of choice, which, you know, has I think pretty profound implications for how we go about not only navigating life generally, but making financial decisions. So there's a whole stack of evolutionary remnants that are built inside of us that really do not map to this traditional economic man model that you also made reference to, and so, you know, a lot of what we're doing, um, at our company, the way we see good financial planners enter their practices day to day, is dealing with people as who they are as opposed to who an economics textbook said they should be.
Jason Pereira: Makes, I mean, again, lots to unpack there. It's the, uh, what's the saying? Nothing's irrational once you understand the journey someone's went, gone through. Right? It all seems irrational subjectively, but, but then when you actually look at them objectively, and it's, the paradox of choice bring up an interesting guest from a previous episode, and it was a friend of mine in marketing who said the Coke remix machines as an example, right? You can come up with any number of combinations. I don't even know what the number is, but it's in the, it's in the hundreds of thousands of combinations, and something like 65 or 66 percent of all selections on the Coke remix machine, is straight Coke. That's it. So we have this world of selection that basically we think we want more, but at the end of the day, it can be overwhelming. And, and most often than not, we just want what we're used to. So not surprising. So the, let's go back to the, um, power brain kind of derails "optimal" in many cases. I mean, you mentioned how we're not wired for that. I mean, it's one of these fascinating things in, in the reading on behavioural finance I've, I've learned about over the years, is the, just how neuro, much neurochemistry energy affects the way we think. Like, for example, if you're thinking about something that you already know, or the more you do something, the less energy your brain expends in order to actually do that thing, as opposed to new learnings. So you're actually more, you're actually using more resources mentally to learn something new than you are something old. And it's, and it basically led to, and one of the things I think that book told me, is that the brain is wired for scarcity. Scarcity of energy, scarcity of resources, and it's not surprising that we oftentimes reach for too much without actually understanding how much is enough. So care to speak to, maybe, like how behavioural finance overlays into that and basically makes us kind of understand where enough is.
Brian Portnoy: Yeah. So let me come sort of around the bend to enough in a minute, but you touched on something really important, which is that the, the brain is a gas guzzler. I don't know if, uh, if that's an American phrase or if that lands in Canada also, but it soaks up a ton of energy. So our brains are roughly 2 1/2 percent of our body weight and use about 25 percent of our caloric load. So sort of a 10x, you know, 10x proportion there. And you're absolutely correct to say that it doesn't want to work that hard. Um, calling it lazy or something like that is not, not the point. The point is that because we are constantly trying to be efficient in the way that we use energy, it produces certain outcomes, especially in the context of our decision making that are quite, quite consequential. So we, we have something in our lives known as confirmation bias, which is that we seek out information that confirms our prior beliefs. So, you know, you have a view as to the way the stock market works, or whether one political party is better than the other, or your favorite sports star is getting better or worse in his or her career, or anything from the, from you know, or, or, or what you think about a particular family member, the brain tends to seek out information that merely aligns to what we were thinking before, which is why when someone confronts you with a fact pattern that doesn't square with what you think, not only do you sort of intellectually, like sort of wrestle with that, it can be even physically uncomfortable. And that confirmation bias is sort of part of a suite of different sort of biases that we have. And I'm not a huge fan of the word bias, but it's popular in behavioural finance literature, so we'll, we use that for now. But we tend to, from an information gathering point of view, and the information producing one decision versus another, our gas guzzling brains steer us toward the status quo. So we find information that confirms what we already believe. We have something called availability bias, meaning that you tend to pay attention to something that's more in front of you, whether it be on the internet or the newspaper or TV or the people that you hang out with, versus going out and finding new sources of information. We have another bias called recency bias, which is that we just tend to pay attention to things that we heard more recently versus something that you heard a long while ago. So all of these sort of efficiency-driven biases lead us to value some forms of information better than others. And so that can land with investors in very particular ways, because if something is going on in the market, first of all, there's a, a deeper issue going on in terms of well, when we sense danger, and red lines on a screen can feel just as physically dangerous as kind of a, a lion in the wild that's roaring at you. And so you feel that fear, your time horizon sort of collapses. You narrow your focus, and the information that you tend to find is exactly of the kind that I just described. It maps to what you already believe, it's what's right in front of you, and it's what you just heard. And this is, can be a real problem when it comes to making sort of more reasonable long term econom, or financial decisions.
Jason Pereira: Well, it's, it's interesting onto that point, 'cause, I mean, I've, now I've read in multiple places that the brain, when under stress, actually performs worse, right? Like our, our IQs actually get, for lack of a better term, dumber, when, when we are under prolonged stress. And our ability to process information just diminishes, right? So it's a bit of a regression back to the, the more primal mine of, you know, we're entrenching ourselves back in survival mode and getting rid of the other things that don't matter in a lot of ways, I would say. So it's, I mean, this, agree to disagree with me on that point, but it's just when those things were –
Brian Portnoy: I don't, I, I might disagree, uh, which **** more fun. I don't know if I disagree, but I just wanna make things a little more complicated, because they need to be, which is that one thing that, and frankly, behavioural finance has not done a good job at this, it's one of the severe limitations of behavioural finance, which comes out of cognitive psychology, meaning that it's just about, hey, you've got a bunch of information, and how do you use that information to make decisions that could produce better outcomes. What that doesn't include at all is our emotions. And I think even among those who claim to be like really into behavioural finance, and a lot of people say that now. It's kind of like the cool kids thing to like be into. The fact is that most, even the people who are into something called behavioural finance don't really appreciate how core emotions are to who we are. They are not sort of something that come after the fact, like the, when, you know, Descartes says I think, therefore, I am, modern neuroscience has actually proven that to be just flat out wrong. It's I feel, therefore, I am. And so, when we talk about getting the emotion out of our financial decision making, especially our investment decision making, that is wrong-headed. That produces stress in an advisor-client relationship. That can produce bad decisions. I think what we need to appreciate is that appreciating what those emotions are, having the right vocabulary for the emotions, whether it's sad, happy, fear, greed, envy, anger, disgust, joy, there's, there's a lot of different words that we can use for our, for our suite of emotions. Appreciating that emotions are central, they are definitive to the human experience, and they're not something that we try to like, push off to the side so that we can get to our rational self. Even behavioural finance, for the most part, and it's a bit of a wonky thing, you know, related to the evolution of the discipline, but traditional behavioural finance does not take that into account.
Jason Pereira: Hmm. It's, it's interesting. You talk about it being the cool kid's thing these days. And it's funny, because one of the things that always, that always kind of really hits me, where I used to remind myself about with this, is that even if we learn about it, even if we try to incorporate this into our practice. And we'll talk about the benefits later as a financial advisor, working with a financial advisor who's taking an incorporation of these beliefs into, into his practice, there's a lot of difficulty in incorporating, anyone incorporating it into their every day lives, a realization of this. I mean even, even Daniel Kahneman basically says that after decades of study of these things, he's no better in recognizing his subject, his, his, um, is falling for these biases any more than the average person is.
Brian Portnoy: Well, but it's, I'm sort of tired of that line. It's a little too clever. Um, and like the guy's, the guy's a genius, and good for Danny Kahneman, but enough of that, to be perfectly honest. Enough of the biases and heuristics generally. It's time to move on. It's funny, like so many people are showing up, like, oh, behavioural finance. This is so cool. And it's like well, yeah, you're falling in love with behavioural finance from 15 years ago. How about we deal with like where the discipline is now in 2023. And so what we're building at Shaping Wealth reflects modern science, not old, dusty stuff. So this idea that, and what's baked into Danny's thing, and, and it's like, I feel like an ass, like trying to like argue in the abstract with the guy who invented the field that I built my career in, but this idea that oh, if I, I, I can still understand all of my "biases" but not fix them, well that's, that's sort of the wrong framing in its foundations anyway. So when I say we're not allowed to use the word rational versus irrational, we can only use the word normal, like let's just focus on that. Because this whole idea of well, if I can learn the biases, then I can do something to get rid of them. Well, I assume you don't have those beeper buttons for profanity, so I'll just say it's BS. That's just not the way we are. And I think when you see this in the financial planning field in, in North America, and there are different organizations that teach behavioural finance, I'm not going to name names unless you force me to, but they basically create curricula that force financial advisors to memorize a bunch of biases. And the idea is well, if you can memorize, if you can diagnose your client, um, appropriately, then you can find ways to fix them. Like there's so many levels of wrong in the way that the industry teaches behavioural finance to advisors right now. I don't even know where to begin. But I've seen these curricula. They teach lists and lists of biases. They say hey, rich people have different biases than poor people. I mean this, this stuff is just offensive, and it's wrong, and what we need to do is stop pathologizing normal human behavior, and just work with the people who show up in all of their messiness and complexity. And oh, by the way, we are identical to our clients sitting across the table. We show up messy and complex. And one of the unsung tasks of modern, call it behavioural finance, is advisors getting to know themselves as well or better than they're getting to know their client, and stop acting like some diagnostic expert in, you know, sort of biases and heuristics.