Book by Dr. Daniel Crosby
Review by Nicholas Haberling
I think I should begin this review with a preface for all future book reviews I write which discuss the market, economy, and business in general: I am not an expert. My education and life experiences up to this point by no means make me qualified to seriously critique the work of those more accomplished than myself. Reviews of this sort will mostly point out observations, areas of interest, and questions.
The Laws of Wealth: Psychology and the Secret to Investing Success was brought to my attention after listening to a The Art of Manliness podcast where the host Brett McKay interviewed Dr. Daniel Crosby, the author of the book. For those interested in listening to the podcast you can find it here. Dr. Crosby’s author page on Amazon depicts his credentials as a, “psychologist, behavioral finance expert and asset manager who applies his study of market psychology to everything from financial product design to security selection.”
I would say The Laws of Wealth makes four major claims:
- The only way to have wealth in retirement is to invest in risk assets.
- The human brain is “psychologically ill-equipped to invest in risk assets.”
- The future is more certain than the present.
- Goal based investing will keep you on track.
The book is split into two sections with the first being rules for behavioral self-management. These rules generally cover the initial four points, however, not every rule or piece of behavioral management advice given addresses the claims explicitly. The first claim is widely understood as a fact of modern life. After you retire there are still bills to pay and without an active income (job, scalable hobby, or pension) the money to pay those bills must come from somewhere. A savings account or money hid under the bed will gradually be eaten away by inflation or more aggressively devoured by increases in cost of living expenses. Dr. Crosby spends some time towards the end of part one discussing how paralysis from a fear to invest can lead us to a far greater fear: unsustainable retirement goals. In summary the only way to prepare for retirement is to invest in assets with potential returns high enough to justify their risk.
The second claim provides us with incites into human behavior and I’d say is the primary focus of the book. Dr. Crosby gives plenty of examples of investors seemingly acting in contrast to their long-term goals such as increasing 401(K) contributions when stock prices hit record highs, but decreasing contributions when prices have fallen. He posits that the key to behavioral self-management is a combination of systems, investment counsel, and diversification. Systems include automating contributions to your investment account and a checklist to go over before making important decisions. Investment counsel is given through a financial advisor who meets a set of criteria Dr. Crosby lists. He cites a Vanguard study which assumes a 3% per year average of added value brought by a financial advisor. Half of which can be attributed to behavioral coaching. Finally, Dr. Crosby touches upon the subject of diversification. While the richest Americans are frequently those who made their fortune from investing in a single business or idea, we would have to have incredible self-bias to think we can duplicate those results. To steal a quote from the book, “Get rich fast and get poor fast are opposing sides of the same coin.” Diversification insulates you from firm specific risks though there is still exposure due to market risk.
The third claim is interesting in the sense that Dr. Crosby presents a series of examples sprinkled throughout the book about how experts and amateurs alike are terrible at predicting the direction of the market and individual securities. Whether its Wall Street forecasts having a 1/170 chance of being within 5% of the actual number or Sir Isaac Newton paying top dollar for the South Sea Company before a market crash, Dr. Crosby seems to enjoy pointing out how terrible we are at predicting the near future. However we can generally assume the future to be bright with the march of the market going upward over time. This faith in the future, justified by historical returns, brings us full circle to the first claim in that risk assets are the only way to prepare for retirement.
The fourth major claim is that goal-based investing will allow you to stay on track for your retirement goals. Dr. Crosby cites a timely example where prior to the 2008 financial crisis, SEI Investments introduced a goal-based investing platform. The statement from Melissa Rayer of SEI that “goals-based investors are less likely to panic and make ill-informed changes in their portfolios,” is self-evident in the data presented.
“Of those in a single, traditional investment portfolio:
- 50% chose to fully liquidate their portfolios or at least their equity portfolios, including many high net worth clients who had no immediate need for cash.
- 10% made significant changes in their equity allocation, reducing it by 25% or more.
Of those clients in a goals-based investment strategy:
- 75% made no changes.
- 20% decided to increase the size of their immediate needs pool, but left their longer-term assets fully invested.”
While Part I of The Laws of Wealth is fairly straightforward and easy to review, Part II, Behavioral Asset Management provides a different set of challenges. Referring back to what I said at the start of this review, I am not experienced or knowledgeable enough to offer a strong opinion on investment philosophies. The section on Managing Behavioral Risk offers advice under four categories on how to avoid the traps emotion driven investing. The next section deals with five hurdles a stock must overcome before being worth the pursuit of an investor. In short, Part II seems to be written for those who are already financial advisors or individuals who would like to add a more personal touch to their investment process.
The Laws of Wealth is a well written introduction to the world of behavioral finance. Dr. Crosby is an entertaining writer and does a wonderful job tying in parables, historical, and modern events into the overarching narrative of the book: human beings are terrible at making long-term finance decisions. I think everyone can take some of the lessons presented in the first half of the book to heart. The second half, while proposing interesting ideas to a novice like myself, may or may not clash with the beliefs of more experienced individuals in the industry.
In conclusion, if you are interested in personal finance I would recommend The Laws of Wealth as an easy to read and thought provoking book. You can find The Laws of Wealth online at Amazon.