Jason interviews Dr. Hersh Shefrin.
Hersh Shefrin is the Mario L. Belotti Professor of Finance at Santa Clara University. He is one of the pioneers in the behavioral approach to economics and finance. The January 2001 issue of CFO magazine lists him among the academic stars of finance. A 2003 article in the American Economic Review listed him as one of the top fifteen economic theorists to have influenced empirical work. In 2009, his behavioral finance book Beyond Greed and Fear: Understanding Behavioral Finance and the Psychology of Investing was recognized by J.P. Morgan Chase as one of the top ten books published since 2000. His books span the entire financial landscape, describing how behavioral ideas impact investment (Beyond Greed and Fear), corporate finance (Behavioral Corporate Finance), asset pricing (A Behavioral Approach to Asset Pricing), and risk management (Behavioral Risk Management). He received a B. Sc. (Hons.) from the University of Manitoba in 1970, an M. Math from the University of Waterloo in 1971, and a Ph.D. from the London School of Economics in 1974. He also holds an honorary doctorate from the University of Oulu, Finland. He is frequently interviewed by the press and in February 2014 his work was profiled on BBC-TV.
Below is the full transcript:
Announcer: Welcome back, America, to Sound Retirement Radio, where we bring you concepts, ideas, and strategies designed to help you achieve clarity, confidence, and freedom as you prepare for and transition through retirement. And now, here is your host, Jason Parker.
Jason: America, welcome back to another round of Sound Retirement Radio. So glad to have you joining us this morning. As you know, we’re always looking to bring experts onto the program who we believe can add significant, meaningful value to your financial life as you’re preparing for and transitioning into and through retirement, so I think you’re going to be really excited to get some insights from Hersh Shefrin, who’s going to be our guest here in just a minute. You’re listening to Episode 136, so if you’re driving down the road in Seattle this morning, I want to remind you we’ve got all these programs archived online at soundretirementplanning.com. As you know, I like to start the morning right, and we do that two ways. First, with a verse, and then with a joke.
The verse I have for us to renew our mind with this morning comes from Luke 6, 35 through 36. Here it is. “But love your enemies, do good to them, and lend to them without expecting to get anything back. Then your reward will be great, and you will be children of the Most High, because he is kind to the ungrateful and wicked. Be merciful, just as your Father is merciful.” That’s awesome. And then, of course, I’ve got a joke for you. I know that you like to go spend time with your grandkids on the weekends, so here’s one for your enjoyment. “What is blue and goes ding dong? An Avon lady at the North Pole.” Stupid. All right, so let’s get into Episode 136. I’ll bring my guest on, do a proper introduction, then throw some great questions at him.
Today, I have Hersh Shefrin on the program. He is the Mario L. Belotti Professor of Finance at Santa Clara University. He is one of the pioneers in the behavioral approach to economics and finance. The January 2001 issue of CFO Magazine lists him among the academic stars of finance. A 2003 article in the American Economic Review listed him as one of the top 15 economic theorists who have influenced empirical work. In 2009, his behavioral finance book Beyond Greed and Fear: Understanding Behavioral Finance and the Psychology of Investing, was recognized by JPMorgan Chase as one of the top 10 books published since 2000. Hersh Shefrin, welcome to Sound Retirement Radio.
Hersh: Thank you so much, Jason. Great to be with you.
Jason: I really appreciate it. I’m going to enjoy this interview, I know, and I’m sure a lot of our listeners will as well. I want to start out. We’ve been talking a little bit about behavioral finance. We had one of your colleagues on the program a couple of weeks ago. I wanted to ask you two questions. Number one, give us a baseline. What is behavioral finance? And then the second part of that question is, Hersh, you’ve been studying this topic for some time, and so I’d like for you to share with our listeners the most important thing you’ve learned from your research.
Hersh: Well, behavioral finance is the application of psychology to financial decision-making, so in a nutshell, it’s really understanding the role that psychological forces play in guiding the way we make judgments about risk and return and the way we make choices about risk and return. So the most important thing that I have learned in over the four decades I’ve been in this area, I think it’s that how we feel and how we think both drive the way that we come to understand the world and react to the world. And it’s important to find ways to let the feeling parts of our brains and the thinking parts of our brains work together to help us make sound decisions, whether it’s about retirement planning or all the other financial aspects of our lives.
Jason: I love that we’re going to apply this to finance, but just to kind of, as a side note, I had the opportunity to go out to lunch with some really amazing people just yesterday, and they’re approaching 80 years old. You wouldn’t know it by spending time with them, by talking to them, by looking at them. They seem very young and vibrant. They are young and vibrant. I mean, they’re out traveling the world and living a great life, and I asked them why it was that they’re doing so well as they approach 80, and at the same time, I’ll meet some people that are 60 that look like they’re falling apart, the wheels are coming off the bus.
And what they said to me was, they said, “Jason, there are some people that we know, a lot of people we know, where they embrace old age, and they are quick to talk about their ailments and the things that are going wrong,” and they say, “We push that away. We don’t want anything to do with it. We really work hard at trying to stay young and active.” And so I think it’s amazing how what we think not only applies to finance, we’re going to get into that, the psychology of finance, but also just how it applies to our overall well-being. Do you have any thoughts on that?
Hersh: So there’s a whole school of thought called positive psychology, and it doesn’t get as much attention among those of us who sort of work in the area of behavioral finance, but I think that we’re beginning to understand just how important it is to get our minds to focus on specific goals, and those goals have to do with specific things that we want in life, concrete, numerical goals, but also goals associated with our overall affect, the way we feel about ourselves, the way we feel about the people we have relationships with, and by consciously thinking about leading a good live, a good ethical life, a good social life, a good financial life, we set ourselves up to move in positive directions, in directions that will get us to where it is that we want to go. And so I think that you had some really important and valuable insights from those folks in their 80s that you spoke with.
Jason: That is one of the reasons why we start every show off by renewing our mind, and it’s important. What are some of the psychological reasons that you think some people are better at retirement planning than others?
Hersh: In large measure, it reflects the impact of nature and nurture. We’re just different. I think that nature has made us so that all of us aren’t cut from the same bolt of cloth. Nature is incredibly important, because, well, financial capability has a strong genetic component. We are only beginning to understand this, but there’s a specific gene that’s been identified in this regard. It’s called the COMT gene. COMT is its nickname. It has a very long chemical name, and there are several variants of this gene, so which variant of the COMT gene you have is highly correlated with how much financial skill you’ll have, innate financial skill. So in large part, we differ in respect to finance and retirement planning when we’re talking about skills because of the way we’re wired. That’s the nature part, and nurture-
Jason: So let me ask you about that, then. On the nature part, is what you’re saying that because some people are wired from birth, that they’re just not going to be very good at it, and is there any way to overcome that before we move into nurture?
Hersh: Well, that’s a great question, and the answer is yes, and it’s like anything else, so some of us were born to be great golfers, and others were born to not be as good a golfer as others. Duffers, I think is the term. But you can take golf lessons so you can be as good as you can be, even though you’re not going to be a professional golfer, and the same is true with finance. There are things that you can do, if you understand your capabilities and understand where you need help, to get some lessons, some coaching, some professional advice, some advice from friends who are experienced, skilled. So yes. I’ll also say, but this is where nurture is going to come in, because coaches, friends, parents, they provide nurturing.
Now, it’s really important to understand the nature part is so strong. It’s really important. Nurture can offset, partly, but nature is pretty much permanent. Your genes are your genes. The nurture part’s going to need to be continually enforced with time because it decays, and parents really want to do the absolute best for their children. They’d like the lessons that they equip their kids with to stay with them their whole lives, and some will, but with financial skills, there’s a tendency for depreciation and deterioration. Not immediately, but they do slack off over time, so there’s much less of an impact that comes from nurturing than from nature, but that doesn’t mean you shouldn’t give up. It just means that you need to be prudent and careful.
Jason: In T. Harv Eker’s book The Millionaire Mind, he talks about the roots determine the fruits. Kind of a catchy like rhyme there, but he talks about how we have these experiences, our roots. Maybe it’s growing up, our experience with money, and how that influences the fruits of our life, how we use some of those lessons we learned early on to make decisions. What are your thoughts about that statement, “Our roots determine the fruits”?
Hersh: Well, we have genetic roots, so we have nature roots, and we have nurture roots. The one thing we know about good financial management at the personal level is that the habits you develop are incredibly important. Having good, sound habits really makes the difference between what’s going to happen down the line and what’s not. Parents who teach their kids routines early on and have those routines be ingrained so that they’re hard to shift out of those good habits into less disciplined habits, those kids will have a leg up going forward. I’ll just mention the very first work I did in the behavioral area back in the 1970s was on understanding the importance of self-control, and in the course of working on the financial aspects of self-control, I came across the work of Walter Mischel, a psychologist then at Stanford University who did very important work with little kids on self-control. The early part of this work, and please forget me for getting professorial and sort of taking a bit of time to answer this question, but it goes right to the heart of what you asked me.
The early part of his study sought to determine which kids could have the discipline to wait a little bit longer to get an extra marshmallow. They set up an experiment where if kids could have patience, instead of getting one marshmallow, they could have two marshmallows. And so he was trying to understand what techniques little kids use to get that extra marshmallow, and which kids have the discipline to get the marshmallow, and which of them simply give up right away and only get one. So he did that study, and he did it with kids who actually were classmates of his own children, and as a result, because they were friends, he learned what happened to those kids later in life. And the amazing thing is that how they behaved at four and whether they could resist a marshmallow was strongly correlated with how successful they were when they became adolescents and adults, because he was able to follow those kids as they grew older.
So those early habits that have to do with things that mentally you can do to get yourself to be disciplined and sometimes your parents can help you and your friends can help you, but sometimes it comes from within, those traits and mental skills wind up being incredibly important for what you do down the line.
Jason: One of my favorite verses is from Philippians 4:11, and it says, “I have learned to be content,” and I love the fact that the author say, “I have learned to be content,” because I don’t think that comes naturally. But along these lines, Dr. Shefrin, I had the opportunity to meet with some folks recently whose parents lived during the Great Depression, and so both of them experienced poverty, and it was interesting to see how the parents’ lives were changed as a result of the experience to poverty. One set saved everything. They never spent any money. I mean, they saved plastic bags from their bread, and little ties that went around the bread. They saved money. They never spent money, so the experience from those parents was to save like crazy because of this experience of the Great Depression. The other parents, though, they lost everything. All their money was in a bank. The bank failed, lost everything, and so their approach after going through the Great Depression was to never save anything, to spend like there’s no tomorrow, because they feel like it could all go away.
So I think it’s interesting how two people can have the same experience of going through a very difficult economic time but come out with two different belief systems in how they approach that. But I wanted to get really specific, because there’s a lot of people wanting to retire today, Dr. Shefrin, and we’re at a time, Robert Shiller’s CAPE ratio has been all through the news recently. It’s approaching 30, so it’s the market, the stocks are looking very expensive based on this cyclically adjusted price-to-earnings ratio. The flip side to that is, 10-year treasuries are paying a little bit more than 2%. 30-year treasuries are paying a little bit less than 3%, so in the economic environment that we’re in today, for people getting ready to retire, what are some of the mistakes you think people are making when it comes to their finances, when it comes to stocks and bonds specifically?
Hersh: Well, it’s probably … All right, so those two features that you mentioned are linked in an important way. You have to be careful to set realistic goals and to understand how much risk it takes to have a good shot of reaching those goals. If you set your goals too high because you’ve been conditioned from the experience of your parents, who lived in a different era, for what is achievable easily, you can wind up in the kind of environment we have now, being frustrated about the low rates from fixed-income securities and ignoring the message, the danger message, from having CAPE being as high as it is, so that you wind up reaching for yield by, for the age you’re at, holding an unbalanced portfolio that’s over weighted in equities, because you can’t stomach the idea of having to accept lower returns. So it’s really about, the first step is to set a goal that’s reasonable in the current environment, even though you’re unhappy with that environment. That can be hard. It can be very frustrating. So the passage that you quoted about learning to be content …
Hersh: … it comes back to that, and in my tradition, in the Jewish tradition, there’s a very similar saying, which asks this question, “Who is rich?” And the answer is, “He who is happy with his lot.” I think that the two concepts are similar, but the learning part that you mentioned, that’s really critical, because learning is about being able to adapt and change, so we have to adapt and change in a way that confronts reality and accepts reality. Once you’ve done that, you can now think about, “All right, what are my menu of options, and which one makes the most sense for me?” It’s always going to be the case that there are some plain vanilla rules to follow for sensible investing, and you simply adapt the parameters for the conditions of your life and time. It has to do with having a well-diversified portfolio, rebalancing, paying very careful attention to expenses, because they tend not to be as salient, so you want your expenses to be low.
Don’t be a do-it-yourselfer if your skill level is low, and you need a little help. Get professional advice, but at the same time, be prudent in who you ask, whose advice you seek in terms of professionals, because some professionals are better than others. You really want to have low-cost products. You really want your financial advisor to be a fiduciary, but it’s plain vanilla advice. It’s about not being too fancy and looking out for your basics, especially retirement, given what’s happening in terms of the, and the political arena, with respect to healthcare. Healthcare is a huge issue. The older you get, the bigger the issue becomes, so that needs to factor in, and your needs for healthcare need to be considered in conjunction with your financial portfolio. Risk is about insurance as much as about equities and fixed income, so it’s about having a holistic balanced view, and not letting your emotions get in the way and putting you into a situation that winds up being detrimental to yourself.
Jason: I like that. I like that a lot. Folks, if you’re just joining us, you’re listening to Episode 136. I have Dr. Hersh Shefrin on the program. He’s Professor of Finance at Santa Clara University. His book, his most recent book was back in 2009, behavioral finance, called Beyond Greed and Fear. Dr. Shefrin, we have a couple minutes left, but if we have people out there that want to learn more about the work that you’re doing today, what’s the best way for them to follow you or to be in contact with you?
Hersh: Well, I have two blogs. I blog for Forbes, and I blog for the Huffington Post, for HuffPost. That’s probably the easiest, which is just to google my name and either Forbes or HuffPost, and then you can easily follow what my current thinking is on issues of general concern. And you can always sort of get to me through the Santa Clara website.
Jason: All right, great. I know that we have a lot of our listeners are in their 50s, and so in the last few minutes here, what are some of the biggest mistakes you think people make financially in their 50s as they’re approaching retirement?
Hersh: Well, many don’t realize that when you’re in your 50s, it’s really your last chance to sock something significant away for retirement. It’s easy to get distracted in your 50s. It’s really a time of change, especially from a family composition perspective, so it’s a time to put a plan in place, and the mistakes have to do with not putting that plan in place when there’s time to actually do something, when there’s more than a decade left before you step down, so thinking about, think ahead first. What’s your retirement going to look like, about how long do you think you’re going to live, and then working backwards, thinking about when you’re going to pay down your debt so that you don’t wind up going into retirement with a lot of a debt burden. You want to think about home size, whether your home is likely to be too big for you five or 10 years from now. You want to think about what you would do with the money if you were to downsize and sell your home.
What are the ways to make prudent use of those funds, and in what ways could you sort of wind up falling into traps and pitfalls and doing something that didn’t make sense? So the thing about being in your 50s is that it’s not only your last big chance to make some important decisions, but you’ve got a lot of, more flexibility than most people have during their 30s and 40s, when they’re basically growing their households. 50s is a time to really take stock. It’s an inflection point to get ready for that next chapter …
Jason: All right.
Hersh: … and to get ready with preparation.
Jason: Folks, if you’re just tuning in to the end of the program here, you’ve been listening to Episode 136. Find us online at Sound Retirement Planning. Dr. Hersh Shefrin has been our guest. Dr. Shefrin, thank you for being a guest on Sound Retirement Radio.
Hersh: It’s been my pleasure to be with you, Jason.
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