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The Three Pillars of Investor Behavior – Safety

The Three Pillars of Investor Behavior – Safety

In the second of a three-part series, Dr. Daniel Crosby examines why safety impacts the quality of the investment experience.

The second pillar of investor behavior that drives a great deal of market movement is a desire for safety. This reality is reflected in one of the hallmark findings of Prospect Theory – that losses deal us a great deal more emotional pain than similarly sized gains give us pleasure.  This asymmetry in preferences means that even more than trying to do well, most investors’ are simply trying not to do poorly. A recent study by State Street, titled “The Influential Investor”, found that the number one desire of respondents was to be more aggressive with their wealth but that the primary asset allocation of those surveyed was cash. This schizophrenic disconnect between desire and behavior shows just how deeply-seated the need for safety truly is.

In addition to being loss averse and desiring safety in general, we have a special psychological need to protect against low levels of overall wealth. Academicians have shaken their heads for some time at the human tendency to do “irrational” things like purchase lottery tickets and insurance in the same day, something seemingly inconsistent with having a single risk profile. However, our need to protect against going broke is so profound that even those comfortable with taking a great deal of financial risk elsewhere are likely to have basic insurance. Gandhi famously said, “To a poor man, bread is God” noting the impossibility of attending to things of highest concern when basic needs are unmet. Something similar could be said of those who fear for their most basic financial needs. Until a client feels a sense of safety, no real good work can be done.

As was the case with the first pillar, simplicity, clients will have a feeling of safety one way or another. It is up to the financial professional to ensure that they are getting real safety that does not jeopardize their long terms in favor of short-term peace of mind. Throughout history, one of the foremost ways that humankind has gained safety is by observing the actions of others and acting in unison. Primitive peoples gathered in groups for safety, efficiencies in hunting and gathering. Furthermore, they observed the actions of others and made decisions accordingly. If your neighbor at a berry and died, you should probably avoid that berry. In modern times, we look to others to “draft” off of the decisions of others, much as a NASCAR drive might draft off the driver ahead. Most all of us suffer decisional fatigue from making hundreds of decisions in the course of an average day, everything from what suit to wear to how to raise our children. This tendency is embodied in The King’s bestselling record, “50,000,000 Elvis Fans Cant’ Be Wrong.”

Decisional drafting is fine if you’re trying to order dinner (“This is our most popular dish.”) but can get us into a great deal of trouble as a way to buy safety in the market. The financial dangers of herding are well understood to savvy professionals and account for the findings of DALBAR and others that show that retail investors, following the behavior of those around them, tend to enter and exit the market at all the wrong times. In addition to trying to time markets with the crowd, investors seek safety by taking themselves out of the market altogether. On a recent trip to the Midwest, I met a farmer, who upon hearing that I worked in the financial services industry, began an angry diatribe about his perceptions of unfairness and corruption in the industry. Curious, I asked him what he did with his money if he was so skeptical of Wall Street, to which he replied that he had a hefty six-figure sum in cash at his home. I tried, with limited efficacy, to impress upon him the risks I saw in his behavior, the risk of theft, natural disaster or at very least decreased purchasing power. While this farmer may seem like an extreme example at first, he is not so different than those in the State Street survey who may know that they need the returns of the market but can be scared to enter.

While allocating to cash and following the herd are not the only ways clients seek safety, they are certainly among the most damaging and are undergird by a common problem. Both behaviors suffer from an external focus rather than an emphasis on personal financial needs. Advisors who work closely with their clients can help them understand that their safety may in no way be impacted by the worries du jour. A long-term investor with a multi year horizon may not be at all impacted by the latest Congressional snafu or the economic woes of some tiny European nation. Similarly, an investor seeking safety in allocating to cash may not realize that his worst fears of low wealth are being met in his failed attempts to manage risk.

It is good and natural for clients to desire safety and it is job one of a financial professional to provide appropriate assurances. Real safety is not found in a mattress full of cash, following the tips of a golf buddy or even beating the benchmark. Real safety, the kind that matters, is a product of appropriate time horizons, a deep understanding of a client’s psychology, and an emphasis on the personal goals that paint their picture of the good life. There is no such thing as risk in abstraction; an event is never risky unless it is risky to someone. By understanding that someone deeply, you also begin to understand how to provide them the financial they so desire. 


Dr. Daniel Crosby is a behavioral finance expert who works with organizations to develop products and messaging to maximize positive investment outcomes. Among his current collaborations is "Personal Benchmark", a system of embedded behavioral finance delivered by Brinker Capital. The title South Gotham is meant to evoke both the foolish side of NYC's financial arena, as well as Crosby's native Atlanta.

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