Why do people make irrational decisions when it comes to investing?

In this episode, I go behind the paywall with a wealth management executive to understand what financial advisors actually do and what makes a good one. I also seek to understand why people make irrational decisions when it comes to investing their money.

Transcript

SPEAKER_01 0:01

Today I am joined by someone who works with financial advisors every day. So feel free to introduce yourself.

SPEAKER_00 0:07

Hi, my name is Dimple Shaw. I am an executive at a company called Ozaic. And Ozaic is a platform that serves about 11,000 financial advisors all throughout the United States.

SPEAKER_01 0:19

And what does a financial advisor do every day?

SPEAKER_00 0:21

Yeah, think of a financial advisor as sort of like a coach around investing. So just like you might have uh you might work with a personal trainer that helps you with health and fitness, a financial advisor is sort of a coach that helps you with investments and saving for the future.

SPEAKER_01 0:39

And who is a typical client for a financial advisor?

SPEAKER_00 0:43

Really, anyone that's earning income at any uh any income level, whether you're just getting started and you are in your first job out of school or you're an ultra-high net worth individual with tens of millions or even hundreds of millions of dollars, um, all of those clients are are great prospects for working with a financial advisor.

SPEAKER_01 1:05

Okay, so getting into it. In an ideal world, how should someone approach investing?

SPEAKER_00 1:10

Yeah, I mean, one of the misconceptions I think that people have around investing, especially early on when you just sort of are getting started and you might be in your first job, is that you can time the market and that you have a sense of what uh when a company's stock might perform well versus when it might not. And so sometimes one of the one of the problem areas that people get into is they start trying to trade on their own and and and time when the market might be going up and when it might be going down, and that's a very hard thing to do because there's a lot of dynamics that go into the performance of individual stocks, and so a financial advisor is great because there's someone that just helps keep you on track and and kind of help you move towards your long-term financial goals.

SPEAKER_01 2:02

So then how would you expect someone that isn't is new to the market, how would you expect them to know when to trade without the help of a financial advisor?

SPEAKER_00 2:12

Yeah, it's pretty tricky because when you look at what the market does, and if you you know, you think about your savings and you might put away money every two weeks when you're earning a paycheck or you know, over years and years into a retirement account. And what happens is when the market goes down and you see that you've saved a lot of money, and all of a sudden your retirement savings takes a big hit, your natural inclination is maybe to try to sell because you're protecting you know what you've earned and you don't want to lose more money, or when a stock is going up, you get this sense that oh wow, there's a run-up in the market or in an individual stock, and people are talking about it, there's a lot of hype, and you might not want to miss out on something. And so then this sort of human tendency is to buy, and that's really backwards from what you actually want to be doing around a portfolio. Um, and so the most important things you can do are one to have a diversified portfolio, two, to kind of buy and hold for the long term, and and three, work with uh a professional that can help keep you on track towards your long-term goals.

SPEAKER_01 3:24

So if I were to see a stock like decreasing exponentially and it just keeps going down after months of keeping it, what am I supposed to do? Just it keeps going down and I'm not sure what to do.

SPEAKER_00 3:35

Yeah, I mean it's it's tricky, right? It depends on what the stock is and it depends on what's driving that price decrease. Um, so if you look at what's been going on over the last couple of years, especially with the Trump administration, there's been a ton of volatility in the market. So if you remember back initially when Trump came into office, he started talking about tariffs, and he was going to put tariffs on all these um goods coming in from foreign companies. Um, and and so there was a big, a pretty sharp decline in the market across all stocks. And then there was a rebound, and then what you saw again when we went to war with Iran, there was a big decline in the stock market, and now it's actually fully rebounded, and the war is still going on. Um, and so all that's to say it really depends on is it sort of something specific going on with an individual company, like they missed, you know, the revenues declining, they missed what we call earnings forecast, which is the guidance that they've given Wall Street on what their performance is going to do, and it's really specific to that company, they've had a big problem, or is it there's something broader going on in the economy or in the market that really is just a short-term issue and is likely to rebound? So it's hard to it's hard to generalize. You really have to understand what's going on kind of more specifically.

SPEAKER_01 5:08

So, but essentially, I should have bought stocks when Trump first introduced the tariffs and they would have rebounded by now, regardless if they were down at first.

SPEAKER_00 5:17

Yeah, I mean it's always good to, you know, consistently put money away. If you, for example, if you know, when you're out of college and you're in a job and you start getting paid every two weeks, you want to start putting at least 20% of that away in a retirement account because over time that's gonna compound and you're gonna have a uh a lot of assets to work with, and and then you want to kind of keep some money on the side that you just have to invest when the market goes down. And so, yes, when markets go down, although the normal human psychology is to sell at those times, the better thing to do is to go into the market and to buy into um differ diversified a diversified portfolio when there's a decline in the market.

SPEAKER_01 6:08

So then why do the large majority of people buy buy shares when they drop and that or sorry, sell shares when they drop and then buy when they're high?

SPEAKER_00 6:17

Yeah, it's really human psychology, right? Which is really interesting, and I think the essence of what you're trying to get at around this whole um your podcast and this discussion, which is why do people do things that are counterintuitive? And really what happens is just the psychology of fear sort of takes over, and people kind of freak out that, oh, you know, I have this retirement account, and it just every time I look at it, it keeps going down and down and down during some short-term period, and you get nervous about losing even more money, and so you decide to pull the trigger and exit when really you probably should have just held on at a minimum, and the better thing to do was use maybe some of the money that you've set aside and bought into the market in those um periods.

SPEAKER_01 7:07

So, from that, would you say investing is more psychological or analytical?

SPEAKER_00 7:12

Yeah, that's a great question and really gets at the heart of what makes a great investor. Most people think that being a great um investor or financial advisor is is really an analytical profession, but when you look at the people of our time, like a Warren Buffett, who's considered the greatest investor of all time, he will say that investing is very much a psychological uh career, and it takes someone that's very steady and sort of thinks about the world differently in order to do really well in the market.

SPEAKER_01 7:45

So are the good investors and the good financial investor financial advisors actually reacting to the market, or are they reacting to societal pressure and fear?

SPEAKER_00 7:56

They're really looking at both. I mean, the the best investors study analytical patterns of the market and more specifically of individual companies, what's going on, what are the expectations that analysts have of how the company is going to perform. But they also look at broader factors around what's going on in the economy, what's going on in that industry, what's, you know, what is the leadership and what sort of is the fundamental premise of that company, and then at the most simple level, is that something that society is going to want more of over time or not? And then they use psychology to think about how to time the investments that they make, both buying in and selling out of individual stocks, broadly speaking.

SPEAKER_01 8:45

So the societal pressure that people create, does this usually encourage people to impulse buy and sell? And from what you've seen, is this typically a beneficial strategy?

SPEAKER_00 8:56

Well, when you see kind of, we call them shocks to the market, like I mentioned a couple of them, the Trump tariffs, the Iran war, um, those are some of the most recent ones. They definitely create fear, and fear is what then triggers a sort of a sell-off in the market. Um, that typically isn't a beneficial strategy for most investors when those things curve occur. The best strategy is basically either to do nothing or as I mentioned earlier, to try to buy into the market when there's a dip in the market.

SPEAKER_01 9:30

So then bringing it back to what we want to get out of this, how do we that everyday person avoid selling low and then buying high?

SPEAKER_00 9:40

Yeah, well, I think the uh, as I was mentioning, a couple things is one, you know, once you start accumulating assets, it's really helpful to have a coach around your investment, someone just to bounce strategies off of, someone to bounce, should is this a good time to sell? Is this a good time to buy? You know, what do you think about these individual assets? Um, and just to get advice. That's definitely one. Uh, the second is typically, unless something's happening with individual stocks, you know, you you usually don't want to sell out of a company just because it goes down. You usually just want to hold. Um, typically, this the stock market is very tied to the performance and the growth of the US economy. And so as long as you're a believer in the growth of the US economy, the stock market is usually going to continue to go up and and grow in value.

SPEAKER_01 10:33

So, do you think taking risks in the stock market is necessary for you to gain money from the market?

SPEAKER_00 10:42

Well, that's a great question. I think ordinarily, no. The the best strategy that one can have is to put money away in a diversified index of what is the S P 500, which is basically investing a little bit in the largest 500 companies in the US. And if you just continue to put some of your money away in that and you let it sit, that money is going to compound and grow over time in value. And then you don't have to worry about timing and when to sell and when to buy.

SPEAKER_01 11:40

So if I was to take that strategy and say, over years gradually increase my money in my retirement account, I would have stable wealth, correct? You know, I'd be comfortable for retirement, I would live a comfortable life. But what separates the people who build the rich, the wealth that we dream of, versus that stable wealth?

SPEAKER_00 12:00

Yeah, I I mean I think you're right. To build the stable wealth is just sort of consistently saving. That's the most important thing you can do, and experiencing that compound growth in retirement accounts. If you want to build insane amounts of wealth, you know, that definitely requires risk taking. And usually the best way to approach that is not necessarily by taking big risks in the market, but by taking risk on yourself and betting on yourself by becoming an entrepreneur or starting a company or um joining a startup, something of that nature.

SPEAKER_01 12:36

So you couldn't become rich off the market alone by taking bets in the market?

SPEAKER_00 12:40

You can or cannot be rich.

SPEAKER_01 12:42

No, it was a qu it was a question. Can because you're saying I would have to become an entrepreneur.

SPEAKER_00 12:46

Right. No, you definitely can become rich by um you bec become very wealthy through the market, but you have to develop a craft in doing that and become an expert in doing that. I mean, one of the richest people in the world, Warren Buffett, has done that by investing, and there's lots and lots of other examples of people who have done that. Um, but it's a craft. You have to have a sense for, as we talked about, a good blend of analytical and psychological skills, great intuition and timing. And uh so so it's a hard strategy to execute, but for those that have that skill, it definitely can work.

SPEAKER_01 13:24

Yeah. Okay, well, thank you so much. That was very interesting.

SPEAKER_00 13:27

Thank you for having me.

SPEAKER_01 13:28

Thank you.