Your Brain Is Stealing $245,000 From Your Retirement (Here's How to Stop It)

Tyler Gardner (0:00)

Our brains, magnificent as they are at things like recognizing faces and remembering song lyrics from 1987, were designed by evolution to keep us alive in the jungle, not to optimize our Roth IRAs. We're running Savannah software on stock market hardware, and it's causing spectacular, expensive errors that would be hilarious if they weren't happening to our actual money.

Hello, friends. This is Tyler Gardner welcoming you to another episode of Your Money Guide on the Side, where it is my job to simplify what seems complex, add nuance to what seems simple, and learn from and alongside some of the brightest minds in money, finance, and investing. So let's get started and get you one step closer to where you need to be. Welcome back to Your Money Guide on the Side, the podcast where we attempt to make your money work harder so you don't have to, or at least so you can worry about it less while you're working hard at other things, like pretending to pay attention during Zoom meetings, or finally learning to make sourdough, which let's be honest, you're never going to do, but I appreciate that we all have our mental endeavors nonetheless. I am thrilled you're still here, genuinely. What I mean by still is we're now at year's end. We've almost made it through an entire year of this podcast journey or endeavor, so as always, before we jump in, A. Thank you. B. I have a small favor to ask, which I promise is less awkward than asking you to borrow money. If this podcast has helped you, maybe prevented you from panic selling during a market dip, helped you understand why index funds aren't actually boring but brilliant, or both, or simply made you feel less alone in your financial confusion, please consider leaving a review on Apple Podcasts, or wherever you're listening. Reviews genuinely help other people discover the show, and they help justify to my spouse that talking into a microphone alone in a room is a real job, and not just an elaborate scheme to avoid household chores. That's just an added benefit. Quick pre-note to this episode. This is one of my longer solo episodes, as there's so much info to unpack here. So, I give you full permission and approval to listen to me on 2x starting now.

Today's episode is the first of yet another two-part series, Mia Culpa, when I start writing, I really do start writing, and I'm genuinely excited about this one. As many of you have been asking me to cover this topic in depth, we're going to tackle behavioral economics, specifically the psychological quirks and mental shortcuts that are systematically destroying your investment returns. And this first episode will cover five biases that you may have heard of, but probably haven't fully appreciated for the portfolio damage they're causing. Think of these as like the greatest hits. These are the ones that get name dropped at dinner parties by people who read one Malcolm Gladwell book and now consider themselves experts on human behavior. I've mentioned many of these behaviors before as subplots in other episodes, but this week and next I'm finally allowing them to take center stage. And next week in part two, we'll dig into the deeper cuts. The behavioral biases that are equally destructive but don't get nearly as much airtime. Consider this your behavioral economics world tour. This week is Madison Square Garden and Wembley Stadium, the venues everyone knows. Next week is the underground clubs and genuine speakeasies where the real magic, or in this case financial carnage, actually happens.

So let me start this week's episode with some data that should make you deeply uncomfortable, because if it doesn't, you're either not paying attention, or you've achieved a level of enlightenment I can only hope to aspire to. According to Dalbar's quantitative analysis of investor behavior, which has been documenting our collective financial self-sabotage for over 30 years, like a very patient therapist who's given up hope will ever change, the average equity investor has consistently, almost heroically, underperformed the stock market itself. Over the 20-year period ending in 2022, the S&P returned approximately 9.8% annually in nominal terms, aka pre-inflation adjustment. The average equity investor, just 6.8%.

That's a 3% point annual gap, which might not sound dramatic until you do the math, at which point you're going to need to sit down. Because on a $100,000 investment over 20 years, that difference is almost a quarter of a million dollars. That's not a rounding error. That's a house in many markets. Well, at least it was during our parents' generation. Or four years of private college tuition. Again, maybe not today, based on what I just saw Wellesley's charging for next year. Or 61,250 artisanal lattes. Or approximately 12,250 avocado toasts, depending on how you prefer to measure financial regret, and whether you live in a city where that toast cost 20 bucks. And here's what makes this particularly painful, like watching yourself trip in a video on repeat. This performance gap isn't because people are invested in terrible high-fee funds managed by someone's incompetent nephew who took one finance class in college and decided he had a gift for this. No, this gap persists even when investors hold perfectly reasonable, low-cost index funds. So even if you've taken the steps that I've tried to outline over the past few years in the content, and you hold low-cost, tax-efficient funds, that's only half the battle. The problem isn't the investments. The problem is the investor. The problem is us. I'm including myself here because I've absolutely made these mistakes, and claiming immunity would be both dishonest and a perfect example of the first bias we're about to discuss. Our brains, magnificent as they are at things like recognizing faces and remembering song lyrics from 1987, were designed by evolution to keep us alive in the jungle, not to optimize our Roth IRAs. We're running Savannah software on stock market hardware, and it's causing spectacular, expensive errors that would be hilarious if they weren't happening to our actual money. Now, here's the quick history, aka what you actually need to know about the academic research that's led to where we are. For most of economic history, economists made a generous, borderline charitable assumption that humans are rational actors who make logical, self-interested decisions based on available information. And man, did we love this theory. This was called rational choice theory, and it was elegant, mathematically beautiful. It won Nobel prizes. But it had one tiny and significant flaw. It was completely, spectacularly wrong. Because then in the 1970s, two Israeli psychologists named Daniel Kahneman and Amos Versky started doing something revolutionary and slightly subversive. They actually asked people questions and watched what they did. Rather than just theorizing about what perfectly rational beings would do in some imaginary universe, they discovered that humans aren't just occasionally irrational when we're tired or hungry, we're predictably, systematically, reliably irrational. We make the same mistakes over and over again, like a sitcom character who somehow never learns that lying always makes things worse. Kahneman and Versky documented dozens of cognitive biases, mental shortcuts and systematic errors in thinking that affect our decisions. Kahneman won the Nobel Prize in Economics for his work in 2002 Versky would have surely shared it, but he'd passed away in 1996, and the Nobel isn't awarded posthumously, unfortunately. Richard Thaler then built on their foundation specifically applying these insights to economic decisions. He documented how real humans save, spend, and invest. Which is to say, poorly, but very consistently, like we're all following the same terrible instruction manual. He also won the Nobel Prize in Economics in 2017, making behavioral economics the most Nobel-heavy field in economics, which is either impressive or a damning indictment of how wrong traditional economics was. I'm going to go with both. The field has exploded since then, giving us a really rich vocabulary for describing our financial foolishness. Anchoring, framing effects, loss aversion, herd behavior, the sunk cost fallacy. These concepts have become part of the cultural conversation, showing up in TED Talks and business books and that one friend who reads too much and won't stop explaining why you're wrong about everything. But here's the thing. Knowing about these biases and actually avoiding them are two entirely different things, like knowing that eating an entire pizza isn't healthy versus actually not eating an entire pizza. The knowledge doesn't make the pizza less appealing, and it certainly doesn't make your brain suddenly start making rational decisions. If anything, it just makes you feel worse about your choices, which is somehow even less helpful. So let's dive into five of the most common, most destructive behavioral biases affecting your portfolio. You've probably heard of some of these, but I'm willing to bet you're still committing them. I certainly am, which is why I've had to build systematic defenses against my own brain, like a financial immune system protecting me from myself. And again, next week, we'll dive into the 2 version with five that maybe you have not heard as much about.