The Behavioral Finance Expert with a Concentrated Multifactor Portfolio

Daniel Crosby, Chief Behavioral Officer at Orion Advisors Solutions, got on the Excess Returns podcast to discuss how he manages his own money.

Show Us Your Portfolio is becoming a segment of my podcast feed that I look forward to because it is one thing to hear what these experts share in the media but another to see how they manage their own money. I am sure if I listened to more episodes, I would be able to pick out specific common themes among most guests.

Daniel is also the host of the Standard Deviations podcast, a podcast about meaning, mind and money. I find many good takeaways from this podcast that readers might be able to learn and implement in their wealth-building journey.

Episode link >>

Good wealth advise in one page:

His Investment Objective: Freedom

“I don’t have fancy tastes. I am a simple man. I don’t need expensive things, but I must be left alone.”

“Live on our own terms, say yes to the things that are valuable to us and say no to those that we don’t.”

“Freedom is everything to me, and it’s why I can do the hard work of saving money and taking risks because I see all these as a service to my freedom. To me, that is much more powerful than a bigger house.”

His Wife and Him Discuss Work Optional A lot

Justin (host) tries to find out whether Daniel and his wife discuss the topic of retirement and along what kind of lines they discuss it. He explains that some may actively work the math in their head that if they accumulate $X based on the 4% withdrawal rate, that will be the goal they accumulate towards but for Justin, he chooses more to do the right thing and takes whether good fortune happens to his family.

Daniel shares that many things he likes pay very poorly (teaching, writing, playing music).

He is not excited to leave the workforce in the future.

Working on something he likes and not depending on whether it pays is a big deal for him.

Value or Growth, Active or Passive, All These Matters Shit Versus Behavioural

Daniel shares that if you invested in the value factor over the past 50 years, $10,000 would have become $2.1 million.

If you invest in the growth factor instead, $10,000 would have become $1.7 million.

There are 7-8 different studies that try to deduce the behavioural gap (difference in return due to our behavioural tendencies). If we average the research, the average investor turns $10,000 only to $415,000.

Over this period, passive did the best, but actively managed investments did very well too.

“All the things we nerds argue about are not as important as long term, patience and good behaviour.”

How Does the Chief Behavioral Officer at Orion Advisor Solutions Take Steps to Reduce Behavioural Mistakes in His Own Portfolio?

Daniel reflected he has not successfully eliminated mistakes but has taken steps and the biggest move is to have his portfolio administered by someone else.

When his portfolio is implemented by someone else, they are doing it:

1. In a way that is consistent with his own thinking and writing.
2. Ultimately, someone else is pulling the trigger.
3. He would care too much if he did it himself.
4. If you want more of a behaviour, you make it incrementally easier.
5. If you want less of a behaviour, you make it incrementally harder.
6. The adviser’s role is to keep Daniel out of the way.

A whole body of research shows people with advisers did way better. Advisers are not great stock pickers. They prevent the clients from tripping over themselves.

“There is a massive difference between knowing what to do, versus doing the right thing.”

Daniel’s adviser is his father. He doesn’t manage any money on his own. He would send them to his adviser. In his opinion, his dad is dispassionate and even-keel but also believes in his son’s investment philosophies. So Daniel allows his dad free reign over his playbook (what he has written).

Daniel and Jack discussed that it could be damn awkward to call your dad that you want to sell out, especially awkward when everyone knows you are the chief behavioural officer.

Which Behavioural Trick Work?

Two best tricks: Automation and Working with Somebody.

Automation: Richard Thaler’s Save More Tomorrow Program

Taking a small amount and allocate as a Play Account is effectively building a “Cheat Day”. Doing this may indirectly teach you that investing can be tough.

The most powerful part of automation is: Reducing the number of decision points.

The Behavioural Take Over Check Your Portfolio

Daily, the markets are up 55% of the time and down 45% of the time. The win/loss probability skew towards a win as the period lengthens.

Losses hit us twice as hard as wins.

While 45% and 55% look quite a close mathematical split, the perceptual split is very different.

The 45% daily would feel like 90% if you check it more often.

If you check less, it is better.

His Main Allocation is Stocks & Cash

He had a bond allocation for the longest time but did not have it for the past couple of years because he felt the returns profile of the bond was not good. He explains to his financial planner (his dad) his rationale, and his dad agrees somewhat given his age (42 years old), this preference away from bonds is not unsound.

Furthermore, he was influenced by Nicolas Nassim Taleb’s barbell portfolio theory concept, and thus he runs a concentrated portfolio, and cash would pair well with such a portfolio.

Another allocation is his personal residential real estate.

Spreadsheet Optimal vs Behavioural Optimal

Daniel developed a bucketing strategy for Orion Advisors Solutions.

There is a distinction between what is spreadsheet optimal versus what is behavioural optimal.

A lot of what Daniel does is not spreadsheet optimal such as paying off his home early when interest rates were extremely low. He also has more cash than the average spreadsheet will tell you. He knew he had to pay off his house to have the bravery or risk tolerance to go further out the risk spectrum with some of his other assets.

Cash has more optionality and helps you sleep better at night.

How he thinks about his equity allocation

Daniel always has aspirations to apply behavioural insights to the management of money.

He runs a concentrated portfolio based on Value, Quality and Momentum style factors.

The universe of stocks is scored based on those three factors, and the top stocks are selected.

• “Value tells where a stock sit/position on a board.”
• “Quality tells what the stock could be when it grows up.”
• “Momentum tells how fast a stock is going to move from point A to point B.”

In short, he looks for high-quality stocks that are attractively priced and going to point B faster.

Investors make a couple of mistakes. If you are going to be passive, be passive by being massively diversified and doing it at a very low cost. If you wish to be active and believe you have an edge in the market, do it in a way that is diversified enough to be humble but convicted enough to sort of gain the benefits of having an edge.

We can get majority of diversification’s benefits by having 15 or 20 stocks.

Either he screens the stocks himself or his dad would do it, and then they just buy it without looking too much at it. This is because a lot of value stocks look like garbage.

Daniel explains that Joel Greenblatt of the Magic stock investing formula offers his solutions in two ways:

1. Go to Joel’s site and take the stocks for free
2. Pay Joel a higher management fee to manage the money for you

Over three years, Joel reviews the performance of the fund versus the S&P 500, and the people who use his screen and SELECTIVELY choose the screened picks and do further research before investing, and observe the people who selectively underperform the S&P 500 while the magic formula outperforms the S&P 500.

“Human discretion is a ceiling not a floor.”

“Investors need a faith”

Dan Egan, the behavioural head at Betterment, said something along these lines. Daniel thinks most of us need to believe in our investment philosophy and strategy because there will be challenging times when you need certain grounding to get you through.

Wrote His First Cheque for an Angel Investment

Daniel explains that with style factor investing, you are not sure whether the style factors will appear, but by tilting your portfolio to the style styles, you are increasing the probability of capturing the returns.

With angel investing, the probability is not in your favour. His first investment in his friend’s company is money he can afford to lose and is operating under the assumption that he will not see the money again.

He hopes His Kids Eventually Do Something They Love

Daniel hopes that he can support his kids in their education and other ways so that they can take up something they love to do.

One of the reasons he can pick up psychology and develop it so well in his career is because he is doing something he likes.

But what we like might not always pay so well initially.

Past Mistakes

Much behavioural stuff

1. It is easier to read about markets in books than how it is in real life.
2. “I overestimated my ability to pick good stocks on a discretionary basis.”
3. “I overestimated my ability to time the market.”
4. “I underemphasize my earning ability. Now I try to crank up the engine to bring in more wealth.”
5. “I have dumb success when I thought it was skill and turns out to be just luck.”
6. “I bought stuff that when to zero based on a tip from a friend.”

“In some ways, you almost have to learn all these lessons yourself. When I look at the Robinhood trading situation in 2020/2021, I know that many people learn lessons, but I just hope that the right lessons were learnt.”

“Get your Beta from the stock market but harvest your Alpha from your job.”

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