June 16, 2022

JF2844: Why Investors Lose Money — How to Stop Misbehaving | Actively Passive Investing Show ft. Travis Watts



In this episode, Travis discusses the highlights from Misbehaving: The Making of Behavioral Economics, a book written by Nobel Prize winner and author Richard H. Thaler. While we often assume most people are logical and rational with their money, Travis explains how Thaler disproves that theory with a number of examples.


1. JCPenney’s Bankruptcy

Years ago, JCPenney brought in a new CEO who decided to do away with the department store’s popular coupons, opting instead to lower prices in the store. Shortly after this decision was made, JCPenney nearly went bankrupt. While the CEO’s logic made sense, the fact of the matter is that humans are dopamine addicts. Just as social media can give us a quick rush of dopamine, JCPenney shoppers felt that same excitement every time they used a coupon to save $20 vs. purchasing items at regular price. When the coupons disappeared, the customers followed suit. 


2. Irrational Human Behavior in Casinos

In his book, Thaler uses this example to demonstrate how negativity bias can cause irrational behavior in casinos. Say you go to Las Vegas with $1,000. You gamble all of it and make $10,000. You receive a dopamine rush of excitement and decided to turn that $10,000 into $20,000. However, you lose half of it. You decide to cash out with your $5,000 and leave the casino feeling defeated. 

Even though in this example you walked into the casino with $1,000 and left with $5,000, you’re still unhappy. This is because you’re focused on the most recent loss of 50% — an example of a cognitive bias known as a negativity bias. 


3. The Depressed Billionaire

Thaler uses another example to demonstrate illogical thinking when it comes to money. Say a successful billionaire experiences a catastrophic event that causes them to lose 90% of their wealth. They still have $100 million, but the pain and negativity they experience from the loss are crushing. Meanwhile, someone who makes $100,000 per year that receives a massive raise to $200,000 a year might be overwhelmingly happier than the ex-billionaire with $100 million. 

“The point is that we as humans don’t rationalize by absolutes, we go by contrast,” Travis explains. “We have to rise above these animal instincts that we have. We need to gain a little bit of perspective, gratitude, and appreciation.”


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Travis Watts: Hello, Best Ever listeners. Welcome back to another episode of The Actively Passive Investing Show. I'm your host, Travis Watts. In today's episode, we're talking about why investors lose money and how to stop misbehaving. Kind of a funny title. It's actually more of a book review; I wanted to share some highlights from a book called Misbehaving, written by Richard Thaler. He's a Nobel Prize winner and author.

He explains why it is that a billionaire could be more depressed than somebody making $100,000 per year. He explains why JCPenney basically went nearly bankrupt after a new CEO came in and took away coupons and set everyday low prices. He explains why humans act irrationally in Las Vegas or in casinos. Pretty interesting book. I'll tie it all into real estate and investing as always, but let me just start by saying this... The assumption most of us have about most people is that most people are logical or rational with their money, for the most part. And I would say that assumption is proven to be incorrect if you read this book. So let's get started and break it down.

I'll start with sharing that story of JCPenney a little bit more in detail. So as years and years ago, they brought in a brand-new CEO. He starts looking at the business model, the business plan, and he says, "You know, we're always sending out these 50% off coupons and stuff like that. Everybody uses them." He said, "It would be more convenient in a cost savings to us if we just did away with coupons. Everyone's using them anyway; let's just take our prices, reduce them to just lower prices, and not do coupons anymore." He said, "We'll be doing a benefit to our customers and a benefit to ourselves." So that sounded good on paper, but what happened is that ran JCPenney virtually into bankruptcy. So sadly, that CEO got booted and fired, left the company, and in a lot of ways, JCPenney's never recovered from that strategy change.

But if you think about it logically, wouldn't that make sense? Why would you want to have to store and cut coupons and bring them into the store if, instead, they would just say, "Hey, we're going to discount it for you anyway, you don't even need the coupon." That makes sense, right? And we see a lot of other retailers in the space using similar strategies. If you've ever bought something from a CVS or Walgreens, they print you out an entire neck scarf of receipts, and that's got extra buck rewards and come back again and we'll give you 20% off one item, plus $2 off this, and $5 off that. And I mean, it's crazy.

But here's the psychology of it. Humans are dopamine addicts. It's why social media works, it's why Instagram and TikTok works so well, because they give us that fast rush of dopamine, just seeing something in an instant. So people get that same feeling from using a coupon. You get that excitement. "Wow, I just saved $20," compared to just buying something that was just regular price.

Pretty interesting to think about, and I'll share with you a little bit more about the Las Vegas situation. So Richard Thaler explains in the book that if you went to Las Vegas with $1,000, let's say, and you go gamble all of it and you end up winning big, you make $10,000. Well, of course, that's going to give you a crazy dopamine rush and excitement. But let's say you keep it going and you say, "I'm going to turn this $10,000 into $20,000." Here we go. Go, and you lose half of it. And now you're down to $5,000.

And then let's say you decide, "Okay, I'm out. I quit, I don't want to lose any more money." You leave the casino you cash out. Statistically speaking, you're going to feel depressed or down or upset or mad about the situation at whole, when in reality, if you just frame it, you walked in with $1,000, and you walked out with $5,000. That's a huge win. That's a very exciting plus. But because of the most recent loss of 50% at the end, you end up feeling bad about it.

This all comes down to cognitive biases that we as humans have. So the latter example there was a negativity bias. So humans are not always rational or logical when it comes to money. That's what this book is all about.

Other examples, by the way, of negativity bias would be the reason why when you tune into the news on TV, it's primarily, let's call it 70%, 80% negativity. It's always war and shootings and stabbings and murders and things like that. It's terrible stuff, because we pay a lot of attention to that, we really tune into that, we give that our full attention.

It's also why right now, as we see the volatility in the stock market and everything's coming to a crash, that you see all these negative headlines start coming out on CNBC and all these news sources of "It's the apocalypse. You better buy my book or my program to know how to save your portfolio." That kind of marketing really works, especially in times of extreme fear, like we're seeing right now in the public markets.

Break: [00:06:35] - [00:08:22]

Travis Watts: So the last example I'll share with you from this book... There's a whole lot more; it's a great book, if you want to check it out. The billionaire example, how a billionaire could be more depressed than someone making $100,000. So in this scenario, again, statistically speaking, if someone were able to make it to the point of being a billionaire, making the Forbes list, huge accomplishment, one of the wealthiest people in the world, and then something catastrophic happens to them or their portfolio, and they lose 90% of their wealth, all the way down to $100 million net worth. The pain and the negativity that is associated with that 90% loss overcomes the total outcome of having $100 billion in the first place.

So what he compares it to in the book is let's say you make $100,000 per year at a job, and your boss gives you a massive pay raise to $200,000 per year. You are statistically a lot happier than the person who has $100 million after a 90% fall of their portfolio value... Which is really crazy to think about, the difference between $200,000 a year in an income and $100 million net worth. I mean, you're still one of the richest people in the world by a longshot with that net worth, but yet a lot of people in that scenario would be depressed or down on themselves.

So the point is that we as humans, we don't rationalize by absolutes, we go by contrast. "I did have $1 billion, now I have 100 million. That really sucks. That's a terrible thing." When the absolute is, "I started from zero and I have $100 million net worth today. That's fantastic."

So I guess the main takeaway, the reason I'm sharing this with you, is as an investor, we have to rise above these animal instincts that we have. We need to gain a little bit of perspective, gratitude, appreciation, let's say... Holding a little bit of perspective has truly been one of the biggest life-changing things in my own experience, in my own life. It's not about keeping up with the Joneses. It's not about focusing in on all of our first-world problems, like going to the grocery store and they're out of your favorite almond milk and now you're all upset for two or three days because you can't have that. It's about realizing that I already have enough simply by living in America. If you've traveled worldwide, you would know that my opinion is I would rather live in poverty in the United States than live middle class in most places around the world.

If you haven't checked out one of my previous episodes, I made one called How to Be Twice as Rich by Desiring Less. It's actually rooted in stoic philosophy from over 2,000 years ago. There's a lot of truth to that, but it's about realizing 689 million people worldwide live in extreme poverty on less than $1.90 per day, that according to the World Bank.

And this, my friends, is why I love books so much. It's the prime example. This book contains the knowledge and the research of one person's entire career. This guy has dedicated everything he's about and everything he is to writing this book to share with us for $20, and then it takes me a couple of weeks to gather those thoughts together, and then it takes even less time to share them with you, and for you tuning into the short little 10-minute episode here today.The value you can get from books like this is invaluable. So just keep in mind the more you learn, the more you earn.

So with that, I'm going to wrap up early. I know that was a really short episode, but I appreciate you guys so much as always. If we haven't connected on social, let's do it. LinkedIn, Facebook, Instagram, BiggerPockets, Travis Watts, and @passiveinvestortips is my handle, and love to be a resource for you or anybody else. Feel free to share this episode and we will see you next week on another episode of The Actively Passive Investing Show.

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