The Anxious Investor' wants to help protect your money from your lizard brain

Scott Nations' new book explores major financial crashes through the lens of behavioral science.

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Myles Ma, CPFCSenior ReporterMyles Ma, CPFC, is a certified personal finance counselor and former senior reporter at Policygenius, where he covered insurance and personal finance. His expertise has been featured in The Washington Post, PBS, CNBC, CBS News, USA Today, HuffPost, Salon, Inc. Magazine, MarketWatch, and elsewhere.

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If investing was only a matter of intelligence, Sir Isaac Newton wouldn’t have lost a fortune during an 18th-century recession. Scott Nations, an author, financial expert, and former CNBC contributor, tells the story of that 1720 crash and several others to explain how human instincts can lead to poor financial decisions — and how you can use behavioral science to avoid those mistakes — in his new book, “The Anxious Investor: Mastering the Mental Game of Investing.” We spoke with Nations about his research process and how to remove some of the anxiety from investing.

Pg: I love how you open the book with the Satan and Hitler-themed advertising for war bonds during World War II. It's such a perfect way to tell the story of emotions and investing. How did you find that particular example? Did you know immediately it would start your book?

SN: I knew from my own reading, and research for my previous book, “A History of the United States in Five Crashes,” that the U.S. Treasury Department’s efforts to sell war bonds to finance the world wars had turned Americans from mere savers into investors. I researched the war bond drives from World War I for that book because those new minted investors got famously carried away in the 1920s. 

The theme of all the war bond drives is that emotions take the lead and personal financial considerations are secondary. Immigrants are told buying war bonds is a way they can prove their loyalty. Mothers hoped their investment might make the difference and keep their son safe. Everyone saw it as an opportunity to do their duty. Money and the return on money didn’t enter into their thinking. 

But in doing that research I came across the story of the Younker Brothers Department Store in Des Moines, and how they went all-out during the bond drives in the 1940s. One of the joys of this type of writing is you come across so many fascinating stories. Some you don’t get to use, but some stay with you. From the moment I read about the Younkers war bond effort I knew it was the best possible example of how emotions often take charge when money is concerned.

The book is rich with historical detail. Why did you think that would be the best way to get this investing advice across? How much work went into the research process?

I think being told we’re not always rational when it comes to money is a bit of an affront to most people. They know they sometimes make financial decisions they wish they could take back, but lecturing readers is no way to convince them how deeply irrational we all can be. But by sharing the narratives of three famous stock market bubbles and subsequent crashes, and then discussing the behavioral biases in the context of those specific events, they see the errors we all make, but they see them displayed by others. I think that’s a more effective way to learn.

It was important to me to be able to prove the existence of these biases and quantify the negative impact they have on our investing results. Some nebulous assertion that investors are overconfident in their ability to pick winning stocks or diversify appropriately isn’t going to convince anyone. But rigorous academic research that uses the scientific method to generate data is more likely to carry the day, and I’ve incorporated a substantial amount of that research and data. This required a lot of work but I also got a lot of help from world-class academics. 

This book seems well suited for the meme stock/cryptocurrency era of finance. Was that intentional? Or was there something else that sparked you to write an investing book at this particular moment?

The first bubble and subsequent crash I discuss involves the South Sea Company and takes place in 1720. The last is the Great Recession in 2008 and 2009. I hope the book is timeless because while I use the South Sea Bubble to discuss the “Disposition Effect,” which is the tendency investors have to sell their profitable investments and keep their unprofitable investments, I could have just as easily used what happened in 2008 and 2009 as an example of disposition. Similarly, I discuss “herding” in the context of the Great Recession but it was fully on display during the South Sea bubble and the internet bubble in 1999.

So the book wasn’t written to warn people away from meme stocks or cryptocurrency specifically, but rather to help them recognize when biases intrude on their investing decisions and to help them by being an entertaining, convincing read.

For example, I show how easy it is for an investor to confuse the disposition effect with a refusal to be greedy. Yes, they’ll sell a winner, but then they’ll pat themselves on the back for not letting greed run away with them. They’ll keep losing stocks and again pat themselves on the back for being patient. A ton of research shows that in selling winners, we’re being immensely greedy, but we're not greedy for money — we’re greedy for the swirl of chemicals that are released in our brains — dopamine is an example — which generate intensely pleasurable sensations when we sell at a profit. Merely having an unrealized profit isn’t as pleasurable, so investors have to sell to get the most of that sensation. Researchers have studied investor’s portfolios and are able to prove, and quantify, that the disposition effect occurs and that it’s harmful to our investing returns.

What's one thing you hope people do differently after reading this book?

I hope they examine their investing decisions in a new light, and then recognize these behavioral biases before they intrude on their own decision-making. 

This book's focus is on how individual investors can master their biases, but do you think there are structural issues at play, too? What are the big market or policy changes you'd make to create a less anxious investing experience?

Great question. Passive investing, often called “indexing,” is one of the greatest advances in personal finance in the past century. I would encourage investors to use passive investing rather than trying to guess which stocks are going to outperform. Indexing is probably the best way for an individual investor to thwart the biases and make investing a less anxious experience. And as data demonstrates, you’ll outperform the active money managers too.

Another approach that can help investors be less anxious and become better investors is to understand what’s normal. Too often, thanks to “availability bias,” we tend to believe that what is memorable is more common than it is. In fact, if you can remember something specific that happened in the stock market, it’s probably exceedingly uncommon. One result is that many investors wildly overestimate the likelihood of a stock market crash — because crashes are so striking and “available” to our memory — and consistently deploy their cash as if another crash is imminent. That’s a horrible way to invest if you have a reasonably long investing timeframe. Understanding what’s normal, and that the math of investing is on your side if you invest and stay invested, is a great way to ease anxiety and improve results.

Finally, sell me your book! What makes it a good investment?

Investing is noble. You’re delaying gratification now in order to fund your retirement or your family’s education. But you can do more damage by not understanding your innate biases, or what is normal in the market, than all the crashes and bear markets in history. This means you’re human. It also means the best way to become a better investor is not by studying finance or stock charts or crunching a bunch of numbers, but instead by reading entertaining narratives which highlight how our behavioral biases intrude and recognizing they are most likely to intrude when we’re anxious.

Image: Gabriella Trujillo