Your own behavior may well be the most important factor in your investment success.

SMI executive editor Mark Biller explained why yesterday on Moody Radio's MoneyWise Live with Rob West and Steve Moore.

Mark also took caller questions, including one about whether investing is too much like gambling.

To listen, click the play button below — or, if you prefer, scroll down for a transcript. (And for more radio appearances by members of the SMI team, visit our Resources page.)

MoneyWise Live airs daily at 4:00 p.m. ET/3:00 CT.

To ask a question on a future program, call 1-800-525-7000 and mention you have a question for either Mark Biller or Matt Bell of Sound Mind Investing.


Steve Moore:  Well, the data is in and it shows that normal human behavior actually prevents us from making smart investing choices. Financial planner and teacher Rob West has called in Mark Biller from Sound Mind Investing to explain. Then, Rob takes your questions at 1-800-525-7000. I'm Steve Moore and welcome to Moneywise Live.

Our friend, Mark Biller is the executive editor at Sound Mind Investing. He helped develop their proven investing strategies — and as an amateur neurologist, he's ready to tell us how the human brain is not our friend when it comes to investing. 

Rob West:  (chuckle) Yes, we have called in the big guns today. Delighted to have you back on Moneywise Live.

Mark Biller:  Well, thanks for having me back.

Steve Moore:  Doctor, always a pleasure.

Rob West:  Yeah. You never know what you're going to be called when Steve is involved.

We know this is a topic that's important to you. It's also really important to our listeners. You know, this idea of human behavior in its intersection with our investment decisions is so powerful. So let's dive right in. You title the cover story in the newsletter this month, The Crucial Role of Behavior in Making Investing Decisions. Explain how our thinking and emotions really combined to influence our investing decisions.

Mark Biller:  Well, over the past 40 years or so, there's been this huge amount of research into investor behavior. It used to be that economists would see people making bad emotional decisions about their money or investments, but they just kind of dismiss that as being irrational — as if that type of behavior was the exception to the rule. And so what this huge body of research over the past few decades has proven is that people are reliably irrational in certain ways and a lot of those impact our investing. So in other words, what we're saying is "irrational is normal" when it comes to our investing, unfortunately.

Rob West:  Yeah. And you know, as we think about that, it's important to understand the implications of that because this clearly shows up in the returns investors earned, doesn't it?

Mark Biller:  Yeah, it sure does. And the article has this really powerful example of that, showing how over this particular 20-year period the stock market gained a little more than 8% per year, but investors actually earned a little under 5% per year. So, a little over 8 for the market versus a little under 5 for investors. That 3-and-a-half percent gap — that was largely due to investor behavior — their buying and selling decisions. And, specifically, that comes from investors getting too aggressive when the market's doing really well, like the market is right now. And especially that shows up from investors getting really fearful and selling at bad times near market bottoms, like we saw in 2008, the early part of the 2000s.

Rob West:  Explain what you think is going on here, Mark. Why is it that we make the opposite decision — whether it's a market that sky high, like the one we're in now, or in a really depressed market situation?

Mark Biller:  Yeah. Human emotions are so powerful and we like to think that we're these logical creatures that are governed by our thoughts and we can keep emotions out of things. And again, this, this big body of behavioral research has just proven that's not true. Our investing decisions follow our emotions and human nature doesn't change over time. We're powerfully driven by fear and greed.

And so when the market does well for an extended period of time — like we've had lately, we've had almost a 10-year bull market with prices going up and up and up — people just extrapolate that performance into the future and think that the good times will never end. They tend to get more and more aggressive and as those prices rise. And then the opposite happens when the markets turn and start going lower. People have a powerful imagination to extrapolate that falling performance indefinitely into the future. They get very fearful and so they pull the plug and sell. 

Rob West:  Yeah. Well, we're going to talk about that, how this affects 401(k)s as well. We're also going to give you some tips on how to overcome this, so that's right around the corner.

Steve Moore:  And your phone calls at 1-800-525-7000.

Steve Moore:  Great to have you with us today. It's a Monday on Moneywise Live. Rob West, your host, is across the virtual table from me today. And our special guest — always a joy to have Mark Biller here from Sound Mind Investing. And we have some open lines right now.

Rob West:  Very good. Mark, this topic is such an important one: the crucial role of behavior in making investment decisions. You know, I'm sure there are listeners out there right now that are resonating with this, whether it's how they've been managing their 401(k) or perhaps, previously, just managing a stock portfolio, making what seems to be in hindsight, the exact opposite decision than they should have depending on whether the market's up or down. We know this is a reality, but one example in the article that I haven't seen before dealt with investors in a 401(k) plan versus investors buying the same exact fund outside of 401(k). How what happened there?

Mark Biller:  Investors that bought this particular fund within their 401(k) plan, they were basically on autopilot —mand that's really the key to this. They were investing the same amount of money into the fund at the same time every month, regardless of what the market was doing. Now the investors outside the 401(k), they bought and sold anytime — there wasn't any imposed structure on their trading, so it was influenced a lot more by their emotional responses to what the market was doing at the time. Now keep in mind, both of these groups are using the exact same mutual funds, so the only significant difference was the one group on autopilot and the other one wasn't. And the results of that were striking. That autopilot 401(k) group that wasn't thinking about what the market was doing, they earned almost 8% per year. That non-401(k) group earned just about 4.3%. So again, 8 versus a little over 4. That behavioral gap was just huge.

Rob West:  Yeah. Well, there's no question about it. So the bottom line we're seeing here is, number one, it's reinforcing if you're a do-it-yourselfer, making sure that you have a disciplined, regular investment strategy — you don't try to time the market that's not really investing. We've said that before. But also it really underscores the importance of having wise counsel, perhaps an investment professional, whether that's a mutual fund manager or an investment advisor, who's actually making these decisions on your behalf, where the emotions have been removed entirely, right?

Mark Biller:  Yeah, that's exactly right. And that's really why people tend to do a little better, I think when they work with somebody, some sort of outside help — because you as an individual, you really need sometimes to have a "brake" on those emotional responses. So whether that's the type of do-it-yourself help that we provide through our newsletter at SMI, or an advisor like a Kingdom Advisor or an SMI Advisor — somebody to work with just to break those worse impulses. You know, when you get worked up and emotional, somebody to say, "Maybe we need to take a step back and reconsider."

Rob West:  Yeah, some steps we can take to overcome this problem of allowing emotions to creep into our investment decisions. One of those you referenced before, which is having a disciplined investment strategy perhaps through a workplace retirement plan. What else can we do?

Mark Biller:  Yeah, and I think that that's really a great key for a lot of people if you have access to a workplace retirement plan because they allow you to so easily automate your investing. And as we saw in that earlier example, automating was a huge key to earning those better returns. Now, even if you're not in a workplace plan, with IRAs and most investment accounts, you can set up automatic instructions that — well let me, let me say it this way, Rob: the thing I like about the automation and setting up those instructions as you make your decisions once with a clear head, instead of having to make the decision every month, "Am I going to send in a new contribution? What's the market been doing?" It just simplifies things so much.

So automating is a great key and then having that written investment plan that we kind of harp on a lot at SMI, that can be another real helpful thing if you've decided in advance how you're going to invest and how you're going to respond to the specific criteria for your buying and selling. That can be so helpful. When the markets get rocky, you can refer back to what you've put in writing before saying, "I'm going to do this and not this." And it just, again, it provides that brake against our worst impulses.

Steve Moore:  We're chatting with Mark Biller and, of course, Rob West — both taking your investing calls right now at 1-800-525-7000. Later in the broadcast, we'll be taking questions on any financial topic. Again, 800-525-700. Let's begin by going down to Florida. Elizabeth, what's your question today?

Elizabeth:  Good afternoon. My question is: What's the difference between buying stock, for example, or contributing to your 401(k), and playing the Lotto? Is one considered investing and the other gambling?

Rob West:  Ah. It's a great question, Elizabeth — and I appreciate you asking because obviously anything we deal with on this program, we want to look at managing your financial life through a biblical lens in light of what God's Word says as the beginning point. We've addressed this topic in the past, but always a great subject. Mark, why don't you start by just weighing in. What is the difference between investing in the stock market and buying a lottery ticket? Is one gambling and one not?

Mark Biller:  Yeah. That is the key distinction between investing and gambling and, and that distinction really boils down to when you're gambling, that is a game of chance there certain odds and you're just playing the odds. Now with investing, some people would say, well, that's all you're doing when you're investing. We would argue that that's not the case, because if you're investing using a, a reasonable approach, then you are actually putting your capital at work in businesses and efforts that are constructive — everyday businesses going on that are serving people, creating products and so forth. And there's a reasonable expectation when you're putting money into a business — just like a small businessman doesn't wake up thinking, you know, "Is it going to be heads or tails today?" — no, the businessmen gets up saying, "What can I do to advance my business, to earn profits, to serve my customers?"
As an investor, we're supplying capital to that businessman to carry on those efforts. So we think that this is not a game of chance — "Is it going to do well? Is it not?" This is a productive effort, over a long term, that we feel should lead to profits — and as an investor you share in those profits. So that's how I would distinguish between the investing versus gambling equation. 

Rob West:  Well, I completely agree. You know, as we look at the counsel of Scripture, we see clearly that this idea of investing is supported — you know, the Parable of the Minas, the Parable of the Talents — the idea that we take what has been entrusted to us and we make it work for us. It's there to provide for us. It's there for helping others. It's there even for our enjoyment, and this idea that we would follow biblical principles which include diversification, which include a long time-horizon, which includes spousal unity. All of those things mean we're investing according to God's plan. But there are clear warnings against "get rich quick." And that's where market timing, or even what you referenced here, Elizabeth, the idea of buying a lottery ticket, I think would fall into the get-rich-quick category, which clearly is discouraged in Scripture. So I would agree wholeheartedly.

Steve Moore:  We had a call that I think sort of disappeared from the screen or something. I'm not sure, Rob. You can walk us through this one, right?

Rob West:  Yes. Cy didn't want to be on the air, but asked an important question — one that we get often, Mark. And that is, "Where do I begin?" You know, as we talk to people day in and day out here on MoneyWise Live, we talk about the importance of saving beginning with the emergency fund and we'll say let's say $1,500 while you're paying the credit cards off. Once those are gone, let's get up to three-to-six months expenses. Then as we begin to invest, let's take advantage of a company match inside a company-sponsored retirement plan.

But beyond that, when somebody, let's say, is putting money into a Roth IRA and they're just beginning, they have a very small amount to invest. Where do they begin in the two questions they're often asking are, as you know, are: "What a broker-dealer or what custodian should I look at it?" And then, "How do I begin in terms of selecting the investments inside that account?"

Mark Biller:  Well, those are great questions to have. They frequently will boil down to the person's investment temperament. Their age often plays a role in that. So really what we're driving at there, Rob, is we're trying to figure out an "investment allocation" that's going to be appropriate for them. Because the younger person — say, you know, a 30-year old person who's opening a Roth IRA — they've got decades of investing ahead of them. They can afford to be very aggressive, maybe have all their money in stocks. Whereas somebody who's older, maybe their 55 and rolling over a 401(k), they're going to have to be much more conservative with their investing choices.
So we have some tools on the Sound Mind Investing website that help people identify the stock/bond allocation that may be appropriate for them. There's a risk-tolerance quiz that people can go through that helps match that up with their season of life to figure out how much should I have in stocks, how much I have in bonds.

Then from there, we can figure out what kind of investing approach do you want? Do you want something very simple that you're using index funds and not having to make investment decisions on a regular basis? Or do you want something that's a little bit more involved, where you're actually changing your investments from time to time. And we would steer them to a different strategy if that's what they wanted, as opposed to an all index fund type of portfolio, which you really could set up just about anywhere. Vanguard. Fidelity, Schwab — they all have great options if you're going to keep it simple like that.

So those are some of the beginning questions that need to be answered as you go about this. It doesn't have to be particularly complicated, once you've settled in on that, um, we have strategies where you can buy two, three, four index funds that cover a broad swath of the market and settle in with something like that very easily. Or again, you can be more active as a person desires.

Steve Moore: And you can find those free resources Mark just mentioned when you visit Evergreen Park, Illinois — Lula, thanks for your patience. What's your question today?

Lula:  Thank you so much for taking my call. My question is, [I have] a pension plan from a former employer, I have to transfer the funds or m ight lose part of it or whatever. But anyway, my current employer does have pre-tax 457 [plan]. Would that be a good idea?

Rob West:  Lula, is it a 401(k) with your previous employer or a pension, what do you have?

Lula:  It's a pension. 

Rob West:  Okay. Mark, what are you seeing as the typical options there?

Mark Biller:  Usually you've got an option there to either take an annuity type of distribution over time from a pension or the option to roll that over into usually a traditional IRA, which can be set up really with any investment provider. Those are the two most common choices. So normally if someone were going to be rolling money out of a pension, it would be to either a mutual-fund company or a broker like I mentioned — Fidelity, Vanguard, Schwab, some of the big names like that. Any of those can handle a rollover from a pension plan into an IRA.

The key with those, typically, is you really want your old employer doing that transfer directly to the company where you're going to have the new account. So you would contact, say, Fidelity or Vanguard, wherever the money's going to, and tell them I have a rollover from this pension plan. And then you would fill out their paperwork and they would actually handle the money. The money would not come through you — and that helps protect you against owing taxes and having unexpected tax implications from that if it goes directly from the employer to the new custodian.

Rob West:  I think that's great advice. Lula, you know, at this point in your life, if you're still working, you're certainly not in retirement, you're probably not looking at the annuitization option. You're looking at that rollover where you can keep the tax away by keeping it inside a direct rollover to an IRA. I think that's going to be your best option. We appreciate your call today.

Mark, we're nearing the end of our segment. Really appreciate you calling this cover article to our attention on the role of behavior and making investment decisions. What would you say to somebody who's listening today, to one that's wondering, "Is that me?" What would be a test, if you will, to know whether or not I'm falling into this trap of letting behavior and emotions have too much of an impact on my investing?

Mark Biller:  You know, Rob, in reality, that's all of us — because we're all subject to these human emotions. But I would say, in particular, if you were an investor back in 2008 and you can kind of recall some of the emotions that were going on. Certainly, if you were someone that either was selling investments or was, was strongly tempted to be selling at that time, that would be a good indication. So just, just being honest with yourself is really the first step of the process. Most of us can use help with us, if we're honest with ourselves.

Steve Moore:  Again, Mark, it's always a great pleasure to have you with us. Thanks very much. You're listening to MoneyWise Live with Rob West. I'm Steve Moore. We'll be right back.