Hugh Massie: Welcome everybody. I'm Hugh Massey, the executive chairman and founder of DNA Behavior International. And today I'm delighted to be hosting our next Behavioral Economics Today podcast. And, you know, in these podcasts, we're exploring the intersection of psychology and economics, looking at your practical areas where we can assist institutions, wealth management firms and individuals with better decision making. And there's no better area to discuss this than directly into the field of behavioral finance, which I put as a subset of behavioral economics, a very big subset in terms of investment decision making. I'm delighted and even proud to have ⁓ Tom Howard with me today to discuss this important area. Tom is an academic. He's also an investment manager. He's the CEO, founder. Athena Invest, which is ⁓ very unique fund management proposition that ⁓ developed out of ⁓ years of ⁓ pioneering work in field of behavioral finance. ⁓ I that ⁓ Tom be proud also for me to acknowledge that he is directly taking on ⁓ modern portfolio theory and challenging that and also risk profiles which is also a very good thing to be challenging as well because that's something that ⁓ actually had an issue with notwithstanding the work we do on personality. So welcome Tom.
Tom Howard: Thank you, Hugh. Glad to be here.
Hugh Massie: All right, so why don't you give us a little bit of sort of your background ⁓ in the field of behavioral finance and what you know what's led you to ⁓ building Athena invest and your unique way of building portfolios.
Tom Howard: Okay. Well, I started out undergraduate engineering. I very much a math guy and a quant guy. And then I worked at Procter & Gamble, ran warehouses and production lines for a while. So that was the real world. And then I went to, on to Oregon State to get a master's in management science, which, which takes the management, what I, that I was doing at Procter & Gamble and put equations around it. And I thought, well, this is pretty cool. And then I went on to get my PhD in finance and economics and statistics. Now for most people, they would run screaming away from that, but I really enjoyed it. I'm very much a quantitative person, particularly the statistics side of it. During that same time, ⁓ modern portfolio theory was arising. And so in the finance part, we went through and derived all the equations and and looked at the analysis and so forth. And so when I came out, modern portfolio theory, this was in the late 70s, was just becoming the center of finance. And I thought that was just fine. I mean, basically what modern portfolio theory says, Tom, you don't have to worry about those messy markets. We've got all these equations that explain things. I said, OK, sounds good to me. ⁓ And so I went to the University of Denver and I started teaching. And I taught this way for quite a while with modern portfolio theory and just looking at the equations. But at the same time, I'm very much an empiricist. I'm a researcher. And I would read the research. Back in those days, Hugh, I actually had to go to the library. I'd walk over, go to the library, and they had all the top journals for each department in the university on.
Hugh Massie: Yeah.
Tom Howard: on shelves. And so I'd walk along and pull off the top finance journals and read them. I kept reading and kept getting the evidence, you know, no matter how elegant the model, if it doesn't work, then you probably shouldn't use it. And the evidence kept getting worse and worse and worse. And then Black Monday, October 19 1987 happened. And I was actually in the University of Denver Library doing some research. And one of my students ran up to me and says, Dr. Howard, Dr. Howard, the stock market just dropped 500 points, which was 22 % that particular day. And I looked him sternly and I said, haven't I taught you better? The stock market can't drop 22%. And so I went over to the librarian just to verify it. And she verified it. And I can remember Hugh standing there and saying, This is the end of my career. I who was going to listen to me talk about investment? I was doing investment seminars around the country and I was teaching ⁓ investments in international finance in the University of Denver Business School. I said, nobody's going to listen to me after this happened. And so I began to explore different ideas. And one of the things that I kept saying is, markets are human institutions. And so they have the same foibles, emotions, and ⁓ behavioral ticks as humans do. And so I started looking at it from that perspective. ⁓ down the way, I began to read the behavioral economics literature and finance literature, which you have read, know, Kahneman, Tversky, and ⁓ all the other folks that have written in this area. And I made decision to move completely away from modern portfolio theory and just look at behavior. And one of the really interesting things that came out of it is that I could use this new idea for building portfolios. And that's what we've done at Athena. ⁓ Build behavioral factor portfolios.
Hugh Massie: Yeah, I think that, you know, what you've what you've really sort of landed the plane on there. And I think people sort of sometimes miss this is that is that the market is a product of human behavior. It's a product of the human behavior of every investor in it. ⁓ You know, whether they're retail, mom and dad investors, wealth manager, investment manager type investors, or they are institutions. every human has biases that affect the overall market. And that's what we really need to understand when we're dealing with markets and designing portfolios, if I understand it the right way and the way you've put it. Because I've always said that humans are, our portfolios are a product of us.
Tom Howard: Yes.
Hugh Massie: and of our behavior. I think that really you're taking that one step further and saying the market is a product of the collective human behavior.
Tom Howard: Exactly. So if we take a look at the stock market, for example, we know that it averages about 10 to 12 percent a year and has for a very long time. You say, so what's driving that? And most people agree that the underlying economy drives about half of that. And then the modern portfolio theory people and many others say, well, the rest is a risk premium. Well, if you look at it carefully.
Hugh Massie: Yeah.
Tom Howard: particularly over long investment horizons, the stock market doesn't seem to be any riskier than the bond market. So why should you have a bond market's 5 to 6 % and the stock market 10 to 12 %? And they call that the equity premium puzzle. People came along and came up with the idea that really it's not a risk premium. It's a an emotion premium because because just like you said, people pile in and out of the market and generally at the wrong time of the markets going down, they get out when it's going up. They they tend to get in. ⁓ And so about half of the return that is the result of emotional and behavioral decisions made by investors. Now, from an investing standpoint, I'd like to harvest that premium.
Hugh Massie: Yep. Yep.
Tom Howard: And I like to build a portfolio that I can harvest that. If investors are willing to provide that premium for me, I'll take it and put it in my portfolio and build long-term wealth. And that's a basic idea behind behavioral investing. I want to stand on the other side and harvest those premiums. And in this case, the stock market is about half of the return. I want to harvest that. And that's why the idea of buy and hold the stock market
Hugh Massie: Jones.
Tom Howard: really does make a lot of logical sense. I'm going to continually harvest that over 10, 20, 30 years, and the result is a lot of long-term wealth.
Hugh Massie: Does that in some way say that you want investors to be emotional to some degree, you're making decisions because it allows for the volatility for you then to capitalize on for your portfolio. But if you're a financial advisor, ⁓ that's the Molotov cocktail in a way that you've got to deal with.
Tom Howard: Yes, yes, that's exactly right. Yeah, again, we'd like to harvest that ⁓ as consistently as possible, not only at the market level, but now the way we build our portfolios at the individual stock level. We look, we stand on the other side of that particular emotional premium driven by behavior and we build portfolios that harvest.
Hugh Massie: So Tom, why don't we progress that to the discussion around risk? Because I think risk is so often defined as volatility. And I'm going to let you address that.
Tom Howard: You know, we'll step back to the 1970s and really back to 1952. ⁓ And the idea that risk was measured by volatility. ⁓ And... This is what kind of the interesting thing about finance and why we went this way. One of the nice things about standard deviation and variance, which is measure of volatility, is it's mathematically tractable. So we can actually build very complicated models, which I did a lot of, and it actually works out and we can get answers. And so we thought, ooh. And then back in those days, economics and finance wanted to be a science. like the ⁓ physics and astronomy people, people, they kept saying to us, well, we're a science, that's finance and economics. And they say to us, well, we put a man on the moon. And so what do we do? How can we become a science? So the idea that the standard deviation and variance was a measure of risk, and in some, I'll talk about it here in a few minutes, what circumstance it is. It really fed into the idea of modeling markets and the standard deviation and the full blown variance covariance matrix. That's kind of a $10 term there. But that is the center of all of this. And so modern portfolio theory got built around that. And everybody accepts it. I mean, even today, you know, you talk to people, you talk to advisors, you talk to professional managers, they talk all the time about volatility as risk. So is volatility really risk? Well, the way we think about it, and I know you think about it this way, we use the needs-based ⁓ financial planning model, sometimes referred to as the bucket model. And what you do is you say, OK, I've got liquidity needs. So how do I fund that?
Hugh Massie: Yeah. Yep.
Tom Howard: And there, clearly, volatility is a risk because I never know when I'm going to need that liquidity and so I've got to get to it. So typically, I'll put it in savings and money markets and those sorts of ⁓ The next level is income. If I'm in a situation where I need regular income, which is typically Jenny Moore when you're retired, I want volatility is still an element of risk there. Not as bad as it is with quitter because you can invest in things and they'll correct themselves. So things like bonds and I really like dividend paying stocks in that area. Then the final bucket, and we always hope that investors and advisors put just what they need, the minimum in each of those two, but then the rest is your growth portfolio. And in your growth portfolio, volatility isn't risk. It's highly emotional, you know, and I'm the same, I'm a professional manager. I should have steely-eyed view of the market and not respond to it, but sure enough. If goes down, I have an emotional reaction. If it goes up, I have an emotional reaction. But if I can get my clients to withstand the volatility, particularly the drawdowns, and not make irrational decisions, then over the long run, again, they reap that ⁓ emotion premium from the market. And they generate tremendous returns. In the case of ⁓ the growth portfolio, the risk is not staying with your plan and not ending up with as much money as you could.
Hugh Massie: So really the key point in all of that in managing volatility is really comes down to the right planning.
Tom Howard: Yes.
Hugh Massie: for the person have the right structure in the buckets, if you want to call it that. So looking at their assets, their cash flows, what they might need in life, ⁓ that for potential life events that are going to come up and have all of that ⁓ well planned, ⁓ around the goals. And then when you get ⁓ the end of that, so as you say, for the growth component ⁓ the buckets. which is the long term portfolio, as you know, you volatility isn't really an issue if the if the right investments are in that, in that bucket. And that's what you've designed portfolios to do, you know, we Athena, and to capitalize ⁓ the inherent emotions that are in the market that are causing ⁓
Tom Howard: Yes. Yes, exactly. so with our the other piece of that, Hugh, and you're very well aware of this is that is the behavioral coaching. So you start out and you develop a plan and we think the bucket model makes sense. And you got a plan and you put it in place and then in six months, the marker goes straight down and your client goes, Whoa, wait a minute, we need to get out of this thing. And so the The coaching is incredibly important. it's that we think from an invited standpoint, the initial thing is building that initial plan, carefully understanding your client. And then ongoing behavioral coaching, education and behavioral coaching. So we have 300 advisors around the country. They use our particular portfolios. The best of those is really interesting when we meet with them. And let's say last month, market went straight down. And we asked them, so did your clients call you? And it turns out they say, basically no, they haven't called me. So they've done this extraordinary job of planning, putting together a plan that makes sense. And you talk about the customization and personalization. And then they work with their clients and educate them and provide the coaching. And it really works. And the result is that the advisor ends up doing much better and so does so to their ⁓ investors and their clients and that turns out to be a really important key.
Hugh Massie: I think the big the big part of that is, know, that I've I've seen with, you know, with the behavioral coaching, it's not just the behavioral coaching of the of the end investor. It's actually also the behavioral coaching of the advisors to make sure that ⁓ they are bought into this and that they can ⁓ handle what's going on. Because if they panic at the wrong time, we'll get emotional, which some of them will. I mean, it's just human nature.
Tom Howard: Yes. Yeah.
Hugh Massie: that's going to seep through to how the clients are managed. And I think that's something that's, you know, very important to recognize that that the advisors themselves really need this behavioral coaching. If this is to be ⁓ to be successful. So let me get into Tom, the thorny subject of risk profiles. ⁓ because I think that they can be ⁓ seen as anti-Christ as such to this. And so I'm going to let you address that.
Tom Howard: Yeah, as you know, we're interested in what people do versus what they say. And when you start out with that initial profile, say, well, could you stand to a 20 % drawdown or a 30? I mean, it just drives me crazy when they ask those questions. And they say, well, yeah, I can do it. Six months later, down 30%. Well, I want to get out now. So what? people say this isn't necessarily what they're going to end up doing. So that's a real problem. The other issue, and again, you've got some really good products that allow advisors to figure out the personalities of their clients. But with the bucket model, and if you put together that initial portfolio and plan correctly, you basically don't even have to consider their risk profile because you've in the initial bucket, you've taken the volatility out. the second bucket, you've taken some of it out. Third bucket, you're with the coaching and so forth and understanding your clients in a fair amount of detail. You can get them through that time. So I think the bucket model and the coaching really negates the need for the so-called risk pull-from. Now, on the other hand, you got to understand the behavior. You got to understand the behavior of clients, right? And why I don't like to, it's really too bad we call it risk. It's behavior and emotions. You need to understand that so you can build the initial plan and then down the way when the world is falling apart, you can coach them to avoid the... cognitive errors and the serious investment mistakes.
Hugh Massie: Yeah, and I think that, you know, to to weigh in what you've said, I even though I am on the side, you know, that my business is, as you said, is all about measuring a person's financial personality, if you want to call it financial DNA of the person. I always had a lot of trouble when I was ⁓ wealth manager myself. In just ⁓ just a very sink and a client of other wealth managers myself. of the risk profiles that were used because they were extremely situational, extremely singular and your answers to those questions will change depending on where the markets are at, which way the wind's blowing, what your mother said to you last night or your wife, you know, it all changes, whereas what I wanted to know was one, the whole person and every element that was driving the decision making. But importantly, what's the hardwired behavior where if we can understand the person, how they instinctively behave and where they're going to go to instinctively, which is really what happens when markets get volatile. and people are under pressure, that's what they revert to. That's in a way what the markets are reflecting. That I wanted to know that to be able to guide the clients and in part, it's not just are they a risk taker or not, but it's also how to communicate with them, where certain biases or preferences are coming from. And, you know, are they a spender and saver as well? Do they want, you know, new solutions or traditional solutions? You know, are they the person that listens to stuff at the dinner party? That was always the one I never liked. And still don't for clients. But that's where I think that you and I, Tom, have for a long time been on a highly complimentary path, because in a way, we're getting to managing the what I suppose what Daniel Kahneman called the system one behaviors. sort of ⁓ to refer to it as level one, because that's what I knew in 2001, till he put his book out thinking fast and slow, but level one or system one, that's really what we're dealing with the markets reflect that. And we've got a man, I believe we've got to manage clients at that level. And, and in the middle of it, the advisors and, I think that's why the risk profile tools, a lot of them out there don't work. I'm not saying all of them are bad because I think some of them do a really good job at, looking at really addressing some of the tolerance levels, you know, your financial tolerance. And that part's important. Like,
Tom Howard: Yes.
Hugh Massie: know, toll risk, think, to be honest, does a good job with that. ⁓ So, you know, it's not that all of the systems out there are bad. But I think what you and I saying, we're saying the risk profile tool measures someone's behavior, they're likely to be highly inaccurate and not doing a good job for building portfolios or behaviorally coaching the client. So that's the huge rant with it. ⁓
Tom Howard: Yeah. And again, I'd much prefer their name, the behavioral profiles. And I think that's exactly what you do. I need to understand how you're going to react to different situations. And ⁓ it's risk to you as a client if you respond incorrectly to that. And my job is to get you to make the best decisions you can for yourself.
Hugh Massie: Yeah, I think that's the part of it to me is, you know, using the term behavioral profile. And that's why I, you know, in a way, change the name of the company from financial DNA to ⁓ behavior was to get to the broader ⁓ help get to the broader person, because that's really what we want to have a discussion about.
Tom Howard: Mm-hmm.
Hugh Massie: Because for the advisor, they're not just dealing with a portfolio, they're dealing with the client's life as well. And that's where some of the portfolio, the structural goals-based portfolio has to be constructed from.
Tom Howard: Yeah. So you put together the plan again and you learn about your clients so you can provide coaching. And really what you want to do is get them on the side of harvesting the behavioral mistakes. That's what, and you don't want them producing the behavioral mistake. You want them to be on the right side of the field and ⁓ therefore, ⁓ harvest those particular premiums, behavioral premiums. ⁓ And so that's really what you're trying to do.
Hugh Massie: So that's really the, what you've just said there, Tom, is the premise of Athena Invest. And do you wanna just talk a little bit more about how you do that? Obviously not giving away your exact secret source, but I think just talk more about the methodology. of that because I think the way I understand it is people can, you know, en masse swoop into a particular stock or institutions do for a particular reason that may not be related to fundamentals. And you're saying there's a price distortion there and that's what gets capitalized on. But I think for you to talk to that a little bit more.
Tom Howard: Yes. Yeah, it's so you know that there's the something like 200 cognitive errors that have been cataloged. I've got the big wheel on my on my wall there that has all 200 of them listed and categorized and so forth. What we've found is that ⁓ going directly at those hasn't worked real well. We know they make this mistake, but we can't seem to.
Hugh Massie: Yeah.
Tom Howard: Again, we can't seem to harvest them. We can't seem to get the benefit of them. So there's been various things that have fallen into my lap. I've read ⁓ articles. I've listened to people talk about things. And I say, hmm, that sounds interesting. ⁓ And ⁓ so we have that idea. so how might we take advantage of that? How might we harvest that benefit? And so then we gather a whole bunch of, we're a big data shop, so we gather a whole bunch of data on that. And what's really interesting in this is we're behavioral, but we are just heavily data. you know, as Daniel Conner.
Hugh Massie: Well, I'm going to argue data is behavior, it's reflection of it.
Tom Howard: So as Daniel Kahneman said, keep your hand firmly on the data. And that's exactly what we do. So even though we're going after these motion behavior, we always ⁓ build it on a base of careful research and a big database, as big a database as we can get, ⁓ wide and as long a time period as we can test it on. And of course, I'm
Hugh Massie: Yep.
Tom Howard: I took the econometrics and all the statistics. So I just love doing that stuff. think I'm, you know, there's not many of me like me in the world likes doing that kind of stuff. Everybody I've talked to just kind of curls the lips of statistics. Anyway, so we go through and test it very carefully. ⁓ And once we test it, say, hey, yeah, this looks like something we could do. Then we have to actually build a methodology for managing. We have to develop a way of managing and making the decision. So then you build your methodology out and once we get the build amount down, then we begin to invest and test that particular portfolio. And so we generally incubate it for a while and when it works, ⁓ then we put it out and begin to offer it to clients. The one portfolio that I've managed for the longest is over 20 years. And it's really kind of an odd portfolio in many respects. It's on the value side. So that's the way to do it. And then finally, ⁓ we use rules-based decisions in making. We don't stick our finger in the wind and say, what's happening here?
Hugh Massie: Yeah.
Tom Howard: I'm just like anybody else. I listen to all the news in the financial markets and all the economy. And you do too. You're just inundated with this. We generally don't use any of that to make our decisions. We've got rules and says, given this situation, this is what we're going to invest in. ⁓ And the last thing I want to do, again, it's that whole thing, do I want to be? generating the opportunity or harvesting the opportunity. And I want to be harvesting the opportunity. The last thing I want to do is manage a portfolio where I'm generating the opportunity. ⁓ And so that's the way we do it.
Hugh Massie: Right. Because I think if you were sitting there and sort of investment committee format, and making decisions, then you're infusing your own bias on top of bias, it's already there in the market. And I suppose and really what we're getting at is that the rules have been designed in such a way that the that the impact of bias is ⁓ largely eliminated, whether it's 100 % eliminated, but it's eliminated to in a way get back to fundamentals investing, which, which Hugh Massey would say is just is more rational investing by ⁓ carving out or eliminating the bias if I'm putting it around that way.
Tom Howard: Yes. Yes, yeah, that's exactly right. You want to protect your portfolio from yourself. And that's what the rules base does.
Hugh Massie: But in a way though, if I was being a complete purist, Tom, you can't even if it's rules based, you can't completely eliminate ⁓ human bias 100 % because there is the person who creates the rules there. But but what you're also saying is the data is largely empirical as far as this is concerned. It gives you a good shot at ⁓ eliminating a lot of the bias, but not all of it.
Tom Howard: Yeah, well, we all work with ourselves, you know. So ⁓ back when I was 40 years old, I don't know your situation, but I married, had kids, I was trying to get promoted at the university, you know, and this question kept coming into my brain and I said, ⁓ no, I'll put that off. I'll think about that later.
Hugh Massie: Heh.
Tom Howard: Finally, when I turned 40, I thought, man, maybe it's time to think about this. And I did, and I'm sure you're very familiar with the journey within, which many people call the scariest journey of all. And you go in and you think about how you make decisions, you go, you know, why am I thinking that way? ⁓ yeah, that memory, that...
Hugh Massie: Yep.
Tom Howard: that event and so forth. And so I began to learn to turn those things off and try to think about things in a more positive way. And I'm a positive person anyway, you know, I had this tape in my head, Tom, you're just not very good. You just, maybe everybody's got the, ⁓ you know, I was a golfer and I kept on saying, Tom, you're just.
Hugh Massie: Yeah.
Tom Howard: You can't hit the ball there. I played competitive golf for years and those thoughts just keep going into your mind. ⁓ And I've made a fair amount of progress turning those off, but they still pop in every once in
Hugh Massie: I think there's no sport like golf, because I play quite a lot of golf. There's no sport like that to allow monkey talk ⁓ to come out, particularly when you're standing over a 20 foot chip ⁓ or the four foot putt ⁓ to win a hole or a tournament. ⁓
Tom Howard: Oof. Yeah.
Hugh Massie: absolutely, you know, that's that that that's what's going on. And you know, it's a it's a tough sport. Look, all sports are tough. And I suppose, you know, investing is the same thing. And, you know, my goal was always to help people become purpose, more financially self empowered, which is what's driven me to this because I was originally a CPA. but but was really teaching people about themselves, the more they know about themselves. the less likely they are to mistakes or to succumb to ⁓ irrationality. We're all going to have something that we're in love with that we might invest in because or got the main knowledge in that somebody else looks at and says, that's a silly thing to do. But I think that the part that you've brought to the table, you know, progressively, you know, through your career, and there's no accident in how your career has unpacked itself, from engineer to now dealing with investment data and human behavior is to help people, as you said, save them from themselves and not make these mistakes. And that's really what we want investors to do and when it becomes the advisor to do, should say when it becomes the advisors mind on the portfolio, the client's eating the advisors advice. ⁓ And that's where I always saw that some of the work I do is really important to stop that. And I think you and I need to, for as long as we can Tom, ⁓ while we also enjoy our golf, ⁓
Tom Howard: Exactly.
Hugh Massie: keep on doing this because hopefully the penny drops more and more.
Tom Howard: Yeah. So, yeah, following up on kind of the inner self, I've really become aware that through the day, I'll feel good or bad about something. And I'm feeling bad and I think, what was it that caused me to feel bad? I go back, maybe it's a story I read or a person I saw. And it really is interesting, Hugh, isn't it? How your emotions. get triggered by all these things. And if you then again let those emotions make your decisions, it turns out many of them are not particularly good decisions. You've got to have the emotions to make the decisions, but you've to have the right emotions to make the decisions.
Hugh Massie: And there's nothing wrong with being in an emotional human being, I think. Yeah, and to display emotions in the right way in certain settings, whether it's in encouraging somebody else or in a personal relationship, you can't always be cold and calculating and withdrawn, which perhaps...
Tom Howard: Yeah, well, we all are.
Hugh Massie: I've been accused of a few times, but, but, you know, you, you, you, you can't always be that, but when it, when it gets to investing, I think that, that, that, the thing is, is to really know where you are on those lines. And even if you are more the calculating, ⁓ researching type person is still emotions involved and you're still going to try and justify
Tom Howard: You
Hugh Massie: a result in something or a particular outcome because you think it's what needs to be done, but it better or decided upon but it might not be right. And and that's where coming back to really what you've been talking about today is a much more data driven approach, but also importantly, I think Tom highlighting what the amount or quantifying what the amount of ⁓ emotion is already built into stock prices.
Tom Howard: Yeah, exactly. ⁓ And people say, we're getting to be smarter. We've got a lot more data. So are we getting to be less emotional? And the answer is, maybe you've seen, I'm sure you've seen it. I think we've gotten more emotional. I'm just amazed. So I'm sitting here in Denver, in place called Dorado Greens.
Hugh Massie: Yeah.
Tom Howard: Really nice area. My golf course out just over the fence in the back. It looks about as safe as you could ever imagine. mean, the world is getting safer. The US is getting safer. And now we live in a community that's really safe. But yet people are just terrified in many cases. I almost think the safer we get, the more afraid we are. And maybe you've looked at that study there, I'm just amazed that we're moving that direction. I think we were almost less afraid back in the middle ages when it really was tremendous risk. You never knew what was going to show up at your door, that white night that turned out to be just awful.
Hugh Massie: think that's what can make a weaker society is that people get too insular and not resilient enough. And I think that's perhaps, ⁓ you know, where we've where we've got to and I think that the affluence that's in our society, and some of the the flaws that are put in place to, you know, to provide protection.
Tom Howard: Yeah.
Hugh Massie: at all levels, whether it's in the family or through the government, ⁓ create that environment. And at some point, that will correct itself.
Tom Howard: I hope so. sit here and the smallest things happening, people just go berserk. And I'm going, come on, let's kind of get this put in perspective. And I think you're right that really do lack the perspective.
Hugh Massie: But risk is also in some ways what you think risk is. know that I think it's a mindset and how you how you take it on. ⁓ And that's also, you know, ⁓ a part of it. And I think that's also ⁓ a in investment markets that it will probably always appear riskier when you don't understand it.
Tom Howard: Yeah, yeah. The example I always look back when I was growing up in the 50s and 60s, my mom would open up the door, the house at eight in the morning and say, go play. And we lived in ⁓ large metropolitan areas. Just go play and come back for dinner. And that's what we did. And ⁓ back then, the crime rate was much higher than it is today, if you look at statistics. ⁓ And then today, people are terrified that they don't have their kids on the cell phone. They have to know where they are all the time and I have to shake my head.
Hugh Massie: Yeah, I I remember when I was like seven years old, my mother taught me how to ride a bike. ⁓ And from thereafter, I was riding a bike five miles to school and back every day, know, rain, hail, shine, ⁓ to sports, all of that type of thing, you know, we were allowed to roam around the streets, my brother, younger brother, he followed not long after. And that's what you did. Whereas today, that isn't going to happen. ⁓
Tom Howard: Mm-hmm. Yeah. Yeah.
Hugh Massie: you everybody's taken everywhere in cars and you know, that's got its implications on health. And but I think also because of the media, we know so much more than maybe we than we used to, we look at human life, perhaps differently. ⁓ You know, so and we are in a way in a complex world. But as you say, I think there was perhaps more risk in, you know, the the earlier life that we had. ⁓
Tom Howard: Yeah, yeah, exactly.
Hugh Massie: So just one, just a couple of things, Tom, to wrap up. Because I think you and I can talk on these issues all day. We talked, I probably quite a lot today, you know, about more what I call retail wealth management, a little that was a little bit slant with advisors, but how should institutional investors be thinking about this? And how should maybe even, you know, the, the wealth managers out there, advisors and the
Tom Howard: Okay. Forever. ⁓
Hugh Massie: individual investor understand the mindsets of institutional investors in this area of ⁓ managing emotion and how portfolios are built.
Tom Howard: The few thoughts on that. ⁓ Let's take the hedge fund industry, for example. And we see this in mutual funds too. It turns out that the smaller hedge funds and the smaller mutual funds perform better. But the big funds get all the money. And so, and that's again, an emotional, ⁓ decision that people make. If you're big, you must be good. If you're small, you must not be good. ⁓ And so that's an issue. institutions, they have to accept kind of people the way they are, which is unfortunate, but they have to. ⁓ The other thing that we see is that investors, when you underperform, they leave you.
Hugh Massie: Yep.
Tom Howard: And if you underperform for two or three years, even though you have just tremendous track record, they leave you. So what's the response of the institutions? Well, we're going to put out closet indexers. So we don't under outperform. And it's as frustrating as it could be. they're recognizing the way ⁓ investors respond on that. And we see it. And we're seeing it right now in the NFL with all the coaches being fired.
Hugh Massie: Yeah.
Tom Howard: Some of these coaches have tremendous records. So they had one bad year or one bad game and they fire. You know.
Hugh Massie: Yeah, they didn't just become bad, obviously, if their if their behavior is what I call morally unacceptable or lacks trust, that's a different issue as opposed to the team didn't overall do as well when they've got a proven track record.
Tom Howard: Yeah. Yeah. so that's, so the institutions are just in a lot of cases responding to the way investors, we'd like the investors to be, you know, more rational and so forth. Although that would do away with our business because all of a sudden those emotion premiums disappear. So I've spent, and you're the same way, I've gone all over the country for years talking about this. and in my classroom and in seminars and in conferences and so forth. How many minds do you suppose I've changed on this stuff? ⁓ You know, people just have their idea. again, from Athena's perspective, it's you know, I'd like to have everybody make good decisions, make a lot of money, but they don't make the best decisions. And we sit on the other side.
Hugh Massie: But in a way, you've you've had very successful portfolio performance on a sustained basis, particularly for those clients that have stayed in on the long term and, you know, follow the advice, you know, the right portfolio structuring, I think it's easy to
Tom Howard: Yes.
Hugh Massie: to sort of look in and say, well, Athena didn't do so well last year, but look at it in a long-term perspective, the portfolio's been well structured and people just haven't made early withdrawals, like you were alluding to at the start, then it all works. That's really the key premise is to be there ⁓ for the long-term. think it's like the work I've done on to help ⁓ and clients understand their system one natural instinctive hardwired behaviors. Has everybody bought into that or want to be bothered with it? Absolutely not. But the ones who have have been very successful, you know, over ⁓ 20 plus year period at engaging clients, but also in building the portfolios. And ⁓ know that because ⁓ I see what happens there's never been phone calls with complaints. And I think that what we have ⁓ and doing is right. You just got to keep, you you got to keep with it. ⁓ And time, you know, I think that because of the chaos we live in, this, I believe this
Tom Howard: Yes, exactly.
Hugh Massie: will bring people back to having to understand their instinctive behavior because what's going on out there is forcing you into that place. So just to wrap up, Tom, there are some ⁓ very famous pioneers out there in the field of behavioral finance. Daniel Kahneman, died a year or so ago and others. But in my mind, your work's equally pioneering and sort of how do you state ⁓ But want to sort of just wrap up by saying how what you've done and concluded upon and act on every day very consistently is different to everybody else in this field. Because I think that that needs to be celebrated more and awarded more.
Tom Howard: Well, thank you very much for saying that. ⁓ You know, again, I've said this several times during our discussion here this afternoon, but I want to get investors and advisors to be harvesting the cognitive errors, the result of the cognitive errors. And it's my job is to identify where we can build portfolios to do that. And so the more you stand on the side of harvesting versus generating
Hugh Massie: Yeah.
Tom Howard: the better you're going to be. And so that's what we try to do through the financial planning all the way up through the investing that we do.
Hugh Massie: And I think if I put it in my practical, you know, sort of nutshell way, the way in which you approach investing and actually you're actually doing it and addressing these biases to capitalize on them, as opposed to, you know, yeah, there's research on on on 200 of these biases that exist that probably if you condense it, there's there may be less and there may be more. But I think there's a lot of research about them.
Tom Howard: Mm-hmm.
Hugh Massie: no one, not very many people know actually how they play out and have gone and measured how they play out. And I think that's really what ⁓ you've gone and done to provide a very concrete, successful strategy for on them and succeeding from an investment perspective.
Tom Howard: It's been the most interesting research I've done in my entire academic career. It's very much Greenfield out here to say, I'm going to build a portfolio based on behavior. And you go, what? What are you doing? But it's really Greenfield. And I've published a lot, continue to write a lot, and very much enjoying it.
Hugh Massie: Well, that's the thing, you you've got, I can tell you enjoy it and love it just going ⁓ Tom. And this going continue to grow. And I hope to and participate that as well. ⁓
Tom Howard: Well, thank you very much, Hugh. I thoroughly enjoyed our conversation.
Hugh Massie: Thank you, Tom.
Tom Howard: Thank you, Hugh. Glad to be here.
Hugh Massie: All right, so why don't you give us a little bit of sort of your background ⁓ in the field of behavioral finance and what you know what's led you to ⁓ building Athena invest and your unique way of building portfolios.
Tom Howard: Okay. Well, I started out undergraduate engineering. I very much a math guy and a quant guy. And then I worked at Procter & Gamble, ran warehouses and production lines for a while. So that was the real world. And then I went to, on to Oregon State to get a master's in management science, which, which takes the management, what I, that I was doing at Procter & Gamble and put equations around it. And I thought, well, this is pretty cool. And then I went on to get my PhD in finance and economics and statistics. Now for most people, they would run screaming away from that, but I really enjoyed it. I'm very much a quantitative person, particularly the statistics side of it. During that same time, ⁓ modern portfolio theory was arising. And so in the finance part, we went through and derived all the equations and and looked at the analysis and so forth. And so when I came out, modern portfolio theory, this was in the late 70s, was just becoming the center of finance. And I thought that was just fine. I mean, basically what modern portfolio theory says, Tom, you don't have to worry about those messy markets. We've got all these equations that explain things. I said, OK, sounds good to me. ⁓ And so I went to the University of Denver and I started teaching. And I taught this way for quite a while with modern portfolio theory and just looking at the equations. But at the same time, I'm very much an empiricist. I'm a researcher. And I would read the research. Back in those days, Hugh, I actually had to go to the library. I'd walk over, go to the library, and they had all the top journals for each department in the university on.
Hugh Massie: Yeah.
Tom Howard: on shelves. And so I'd walk along and pull off the top finance journals and read them. I kept reading and kept getting the evidence, you know, no matter how elegant the model, if it doesn't work, then you probably shouldn't use it. And the evidence kept getting worse and worse and worse. And then Black Monday, October 19 1987 happened. And I was actually in the University of Denver Library doing some research. And one of my students ran up to me and says, Dr. Howard, Dr. Howard, the stock market just dropped 500 points, which was 22 % that particular day. And I looked him sternly and I said, haven't I taught you better? The stock market can't drop 22%. And so I went over to the librarian just to verify it. And she verified it. And I can remember Hugh standing there and saying, This is the end of my career. I who was going to listen to me talk about investment? I was doing investment seminars around the country and I was teaching ⁓ investments in international finance in the University of Denver Business School. I said, nobody's going to listen to me after this happened. And so I began to explore different ideas. And one of the things that I kept saying is, markets are human institutions. And so they have the same foibles, emotions, and ⁓ behavioral ticks as humans do. And so I started looking at it from that perspective. ⁓ down the way, I began to read the behavioral economics literature and finance literature, which you have read, know, Kahneman, Tversky, and ⁓ all the other folks that have written in this area. And I made decision to move completely away from modern portfolio theory and just look at behavior. And one of the really interesting things that came out of it is that I could use this new idea for building portfolios. And that's what we've done at Athena. ⁓ Build behavioral factor portfolios.
Hugh Massie: Yeah, I think that, you know, what you've what you've really sort of landed the plane on there. And I think people sort of sometimes miss this is that is that the market is a product of human behavior. It's a product of the human behavior of every investor in it. ⁓ You know, whether they're retail, mom and dad investors, wealth manager, investment manager type investors, or they are institutions. every human has biases that affect the overall market. And that's what we really need to understand when we're dealing with markets and designing portfolios, if I understand it the right way and the way you've put it. Because I've always said that humans are, our portfolios are a product of us.
Tom Howard: Yes.
Hugh Massie: and of our behavior. I think that really you're taking that one step further and saying the market is a product of the collective human behavior.
Tom Howard: Exactly. So if we take a look at the stock market, for example, we know that it averages about 10 to 12 percent a year and has for a very long time. You say, so what's driving that? And most people agree that the underlying economy drives about half of that. And then the modern portfolio theory people and many others say, well, the rest is a risk premium. Well, if you look at it carefully.
Hugh Massie: Yeah.
Tom Howard: particularly over long investment horizons, the stock market doesn't seem to be any riskier than the bond market. So why should you have a bond market's 5 to 6 % and the stock market 10 to 12 %? And they call that the equity premium puzzle. People came along and came up with the idea that really it's not a risk premium. It's a an emotion premium because because just like you said, people pile in and out of the market and generally at the wrong time of the markets going down, they get out when it's going up. They they tend to get in. ⁓ And so about half of the return that is the result of emotional and behavioral decisions made by investors. Now, from an investing standpoint, I'd like to harvest that premium.
Hugh Massie: Yep. Yep.
Tom Howard: And I like to build a portfolio that I can harvest that. If investors are willing to provide that premium for me, I'll take it and put it in my portfolio and build long-term wealth. And that's a basic idea behind behavioral investing. I want to stand on the other side and harvest those premiums. And in this case, the stock market is about half of the return. I want to harvest that. And that's why the idea of buy and hold the stock market
Hugh Massie: Jones.
Tom Howard: really does make a lot of logical sense. I'm going to continually harvest that over 10, 20, 30 years, and the result is a lot of long-term wealth.
Hugh Massie: Does that in some way say that you want investors to be emotional to some degree, you're making decisions because it allows for the volatility for you then to capitalize on for your portfolio. But if you're a financial advisor, ⁓ that's the Molotov cocktail in a way that you've got to deal with.
Tom Howard: Yes, yes, that's exactly right. Yeah, again, we'd like to harvest that ⁓ as consistently as possible, not only at the market level, but now the way we build our portfolios at the individual stock level. We look, we stand on the other side of that particular emotional premium driven by behavior and we build portfolios that harvest.
Hugh Massie: So Tom, why don't we progress that to the discussion around risk? Because I think risk is so often defined as volatility. And I'm going to let you address that.
Tom Howard: You know, we'll step back to the 1970s and really back to 1952. ⁓ And the idea that risk was measured by volatility. ⁓ And... This is what kind of the interesting thing about finance and why we went this way. One of the nice things about standard deviation and variance, which is measure of volatility, is it's mathematically tractable. So we can actually build very complicated models, which I did a lot of, and it actually works out and we can get answers. And so we thought, ooh. And then back in those days, economics and finance wanted to be a science. like the ⁓ physics and astronomy people, people, they kept saying to us, well, we're a science, that's finance and economics. And they say to us, well, we put a man on the moon. And so what do we do? How can we become a science? So the idea that the standard deviation and variance was a measure of risk, and in some, I'll talk about it here in a few minutes, what circumstance it is. It really fed into the idea of modeling markets and the standard deviation and the full blown variance covariance matrix. That's kind of a $10 term there. But that is the center of all of this. And so modern portfolio theory got built around that. And everybody accepts it. I mean, even today, you know, you talk to people, you talk to advisors, you talk to professional managers, they talk all the time about volatility as risk. So is volatility really risk? Well, the way we think about it, and I know you think about it this way, we use the needs-based ⁓ financial planning model, sometimes referred to as the bucket model. And what you do is you say, OK, I've got liquidity needs. So how do I fund that?
Hugh Massie: Yeah. Yep.
Tom Howard: And there, clearly, volatility is a risk because I never know when I'm going to need that liquidity and so I've got to get to it. So typically, I'll put it in savings and money markets and those sorts of ⁓ The next level is income. If I'm in a situation where I need regular income, which is typically Jenny Moore when you're retired, I want volatility is still an element of risk there. Not as bad as it is with quitter because you can invest in things and they'll correct themselves. So things like bonds and I really like dividend paying stocks in that area. Then the final bucket, and we always hope that investors and advisors put just what they need, the minimum in each of those two, but then the rest is your growth portfolio. And in your growth portfolio, volatility isn't risk. It's highly emotional, you know, and I'm the same, I'm a professional manager. I should have steely-eyed view of the market and not respond to it, but sure enough. If goes down, I have an emotional reaction. If it goes up, I have an emotional reaction. But if I can get my clients to withstand the volatility, particularly the drawdowns, and not make irrational decisions, then over the long run, again, they reap that ⁓ emotion premium from the market. And they generate tremendous returns. In the case of ⁓ the growth portfolio, the risk is not staying with your plan and not ending up with as much money as you could.
Hugh Massie: So really the key point in all of that in managing volatility is really comes down to the right planning.
Tom Howard: Yes.
Hugh Massie: for the person have the right structure in the buckets, if you want to call it that. So looking at their assets, their cash flows, what they might need in life, ⁓ that for potential life events that are going to come up and have all of that ⁓ well planned, ⁓ around the goals. And then when you get ⁓ the end of that, so as you say, for the growth component ⁓ the buckets. which is the long term portfolio, as you know, you volatility isn't really an issue if the if the right investments are in that, in that bucket. And that's what you've designed portfolios to do, you know, we Athena, and to capitalize ⁓ the inherent emotions that are in the market that are causing ⁓
Tom Howard: Yes. Yes, exactly. so with our the other piece of that, Hugh, and you're very well aware of this is that is the behavioral coaching. So you start out and you develop a plan and we think the bucket model makes sense. And you got a plan and you put it in place and then in six months, the marker goes straight down and your client goes, Whoa, wait a minute, we need to get out of this thing. And so the The coaching is incredibly important. it's that we think from an invited standpoint, the initial thing is building that initial plan, carefully understanding your client. And then ongoing behavioral coaching, education and behavioral coaching. So we have 300 advisors around the country. They use our particular portfolios. The best of those is really interesting when we meet with them. And let's say last month, market went straight down. And we asked them, so did your clients call you? And it turns out they say, basically no, they haven't called me. So they've done this extraordinary job of planning, putting together a plan that makes sense. And you talk about the customization and personalization. And then they work with their clients and educate them and provide the coaching. And it really works. And the result is that the advisor ends up doing much better and so does so to their ⁓ investors and their clients and that turns out to be a really important key.
Hugh Massie: I think the big the big part of that is, know, that I've I've seen with, you know, with the behavioral coaching, it's not just the behavioral coaching of the of the end investor. It's actually also the behavioral coaching of the advisors to make sure that ⁓ they are bought into this and that they can ⁓ handle what's going on. Because if they panic at the wrong time, we'll get emotional, which some of them will. I mean, it's just human nature.
Tom Howard: Yes. Yeah.
Hugh Massie: that's going to seep through to how the clients are managed. And I think that's something that's, you know, very important to recognize that that the advisors themselves really need this behavioral coaching. If this is to be ⁓ to be successful. So let me get into Tom, the thorny subject of risk profiles. ⁓ because I think that they can be ⁓ seen as anti-Christ as such to this. And so I'm going to let you address that.
Tom Howard: Yeah, as you know, we're interested in what people do versus what they say. And when you start out with that initial profile, say, well, could you stand to a 20 % drawdown or a 30? I mean, it just drives me crazy when they ask those questions. And they say, well, yeah, I can do it. Six months later, down 30%. Well, I want to get out now. So what? people say this isn't necessarily what they're going to end up doing. So that's a real problem. The other issue, and again, you've got some really good products that allow advisors to figure out the personalities of their clients. But with the bucket model, and if you put together that initial portfolio and plan correctly, you basically don't even have to consider their risk profile because you've in the initial bucket, you've taken the volatility out. the second bucket, you've taken some of it out. Third bucket, you're with the coaching and so forth and understanding your clients in a fair amount of detail. You can get them through that time. So I think the bucket model and the coaching really negates the need for the so-called risk pull-from. Now, on the other hand, you got to understand the behavior. You got to understand the behavior of clients, right? And why I don't like to, it's really too bad we call it risk. It's behavior and emotions. You need to understand that so you can build the initial plan and then down the way when the world is falling apart, you can coach them to avoid the... cognitive errors and the serious investment mistakes.
Hugh Massie: Yeah, and I think that, you know, to to weigh in what you've said, I even though I am on the side, you know, that my business is, as you said, is all about measuring a person's financial personality, if you want to call it financial DNA of the person. I always had a lot of trouble when I was ⁓ wealth manager myself. In just ⁓ just a very sink and a client of other wealth managers myself. of the risk profiles that were used because they were extremely situational, extremely singular and your answers to those questions will change depending on where the markets are at, which way the wind's blowing, what your mother said to you last night or your wife, you know, it all changes, whereas what I wanted to know was one, the whole person and every element that was driving the decision making. But importantly, what's the hardwired behavior where if we can understand the person, how they instinctively behave and where they're going to go to instinctively, which is really what happens when markets get volatile. and people are under pressure, that's what they revert to. That's in a way what the markets are reflecting. That I wanted to know that to be able to guide the clients and in part, it's not just are they a risk taker or not, but it's also how to communicate with them, where certain biases or preferences are coming from. And, you know, are they a spender and saver as well? Do they want, you know, new solutions or traditional solutions? You know, are they the person that listens to stuff at the dinner party? That was always the one I never liked. And still don't for clients. But that's where I think that you and I, Tom, have for a long time been on a highly complimentary path, because in a way, we're getting to managing the what I suppose what Daniel Kahneman called the system one behaviors. sort of ⁓ to refer to it as level one, because that's what I knew in 2001, till he put his book out thinking fast and slow, but level one or system one, that's really what we're dealing with the markets reflect that. And we've got a man, I believe we've got to manage clients at that level. And, and in the middle of it, the advisors and, I think that's why the risk profile tools, a lot of them out there don't work. I'm not saying all of them are bad because I think some of them do a really good job at, looking at really addressing some of the tolerance levels, you know, your financial tolerance. And that part's important. Like,
Tom Howard: Yes.
Hugh Massie: know, toll risk, think, to be honest, does a good job with that. ⁓ So, you know, it's not that all of the systems out there are bad. But I think what you and I saying, we're saying the risk profile tool measures someone's behavior, they're likely to be highly inaccurate and not doing a good job for building portfolios or behaviorally coaching the client. So that's the huge rant with it. ⁓
Tom Howard: Yeah. And again, I'd much prefer their name, the behavioral profiles. And I think that's exactly what you do. I need to understand how you're going to react to different situations. And ⁓ it's risk to you as a client if you respond incorrectly to that. And my job is to get you to make the best decisions you can for yourself.
Hugh Massie: Yeah, I think that's the part of it to me is, you know, using the term behavioral profile. And that's why I, you know, in a way, change the name of the company from financial DNA to ⁓ behavior was to get to the broader ⁓ help get to the broader person, because that's really what we want to have a discussion about.
Tom Howard: Mm-hmm.
Hugh Massie: Because for the advisor, they're not just dealing with a portfolio, they're dealing with the client's life as well. And that's where some of the portfolio, the structural goals-based portfolio has to be constructed from.
Tom Howard: Yeah. So you put together the plan again and you learn about your clients so you can provide coaching. And really what you want to do is get them on the side of harvesting the behavioral mistakes. That's what, and you don't want them producing the behavioral mistake. You want them to be on the right side of the field and ⁓ therefore, ⁓ harvest those particular premiums, behavioral premiums. ⁓ And so that's really what you're trying to do.
Hugh Massie: So that's really the, what you've just said there, Tom, is the premise of Athena Invest. And do you wanna just talk a little bit more about how you do that? Obviously not giving away your exact secret source, but I think just talk more about the methodology. of that because I think the way I understand it is people can, you know, en masse swoop into a particular stock or institutions do for a particular reason that may not be related to fundamentals. And you're saying there's a price distortion there and that's what gets capitalized on. But I think for you to talk to that a little bit more.
Tom Howard: Yes. Yeah, it's so you know that there's the something like 200 cognitive errors that have been cataloged. I've got the big wheel on my on my wall there that has all 200 of them listed and categorized and so forth. What we've found is that ⁓ going directly at those hasn't worked real well. We know they make this mistake, but we can't seem to.
Hugh Massie: Yeah.
Tom Howard: Again, we can't seem to harvest them. We can't seem to get the benefit of them. So there's been various things that have fallen into my lap. I've read ⁓ articles. I've listened to people talk about things. And I say, hmm, that sounds interesting. ⁓ And ⁓ so we have that idea. so how might we take advantage of that? How might we harvest that benefit? And so then we gather a whole bunch of, we're a big data shop, so we gather a whole bunch of data on that. And what's really interesting in this is we're behavioral, but we are just heavily data. you know, as Daniel Conner.
Hugh Massie: Well, I'm going to argue data is behavior, it's reflection of it.
Tom Howard: So as Daniel Kahneman said, keep your hand firmly on the data. And that's exactly what we do. So even though we're going after these motion behavior, we always ⁓ build it on a base of careful research and a big database, as big a database as we can get, ⁓ wide and as long a time period as we can test it on. And of course, I'm
Hugh Massie: Yep.
Tom Howard: I took the econometrics and all the statistics. So I just love doing that stuff. think I'm, you know, there's not many of me like me in the world likes doing that kind of stuff. Everybody I've talked to just kind of curls the lips of statistics. Anyway, so we go through and test it very carefully. ⁓ And once we test it, say, hey, yeah, this looks like something we could do. Then we have to actually build a methodology for managing. We have to develop a way of managing and making the decision. So then you build your methodology out and once we get the build amount down, then we begin to invest and test that particular portfolio. And so we generally incubate it for a while and when it works, ⁓ then we put it out and begin to offer it to clients. The one portfolio that I've managed for the longest is over 20 years. And it's really kind of an odd portfolio in many respects. It's on the value side. So that's the way to do it. And then finally, ⁓ we use rules-based decisions in making. We don't stick our finger in the wind and say, what's happening here?
Hugh Massie: Yeah.
Tom Howard: I'm just like anybody else. I listen to all the news in the financial markets and all the economy. And you do too. You're just inundated with this. We generally don't use any of that to make our decisions. We've got rules and says, given this situation, this is what we're going to invest in. ⁓ And the last thing I want to do, again, it's that whole thing, do I want to be? generating the opportunity or harvesting the opportunity. And I want to be harvesting the opportunity. The last thing I want to do is manage a portfolio where I'm generating the opportunity. ⁓ And so that's the way we do it.
Hugh Massie: Right. Because I think if you were sitting there and sort of investment committee format, and making decisions, then you're infusing your own bias on top of bias, it's already there in the market. And I suppose and really what we're getting at is that the rules have been designed in such a way that the that the impact of bias is ⁓ largely eliminated, whether it's 100 % eliminated, but it's eliminated to in a way get back to fundamentals investing, which, which Hugh Massey would say is just is more rational investing by ⁓ carving out or eliminating the bias if I'm putting it around that way.
Tom Howard: Yes. Yes, yeah, that's exactly right. You want to protect your portfolio from yourself. And that's what the rules base does.
Hugh Massie: But in a way though, if I was being a complete purist, Tom, you can't even if it's rules based, you can't completely eliminate ⁓ human bias 100 % because there is the person who creates the rules there. But but what you're also saying is the data is largely empirical as far as this is concerned. It gives you a good shot at ⁓ eliminating a lot of the bias, but not all of it.
Tom Howard: Yeah, well, we all work with ourselves, you know. So ⁓ back when I was 40 years old, I don't know your situation, but I married, had kids, I was trying to get promoted at the university, you know, and this question kept coming into my brain and I said, ⁓ no, I'll put that off. I'll think about that later.
Hugh Massie: Heh.
Tom Howard: Finally, when I turned 40, I thought, man, maybe it's time to think about this. And I did, and I'm sure you're very familiar with the journey within, which many people call the scariest journey of all. And you go in and you think about how you make decisions, you go, you know, why am I thinking that way? ⁓ yeah, that memory, that...
Hugh Massie: Yep.
Tom Howard: that event and so forth. And so I began to learn to turn those things off and try to think about things in a more positive way. And I'm a positive person anyway, you know, I had this tape in my head, Tom, you're just not very good. You just, maybe everybody's got the, ⁓ you know, I was a golfer and I kept on saying, Tom, you're just.
Hugh Massie: Yeah.
Tom Howard: You can't hit the ball there. I played competitive golf for years and those thoughts just keep going into your mind. ⁓ And I've made a fair amount of progress turning those off, but they still pop in every once in
Hugh Massie: I think there's no sport like golf, because I play quite a lot of golf. There's no sport like that to allow monkey talk ⁓ to come out, particularly when you're standing over a 20 foot chip ⁓ or the four foot putt ⁓ to win a hole or a tournament. ⁓
Tom Howard: Oof. Yeah.
Hugh Massie: absolutely, you know, that's that that that's what's going on. And you know, it's a it's a tough sport. Look, all sports are tough. And I suppose, you know, investing is the same thing. And, you know, my goal was always to help people become purpose, more financially self empowered, which is what's driven me to this because I was originally a CPA. but but was really teaching people about themselves, the more they know about themselves. the less likely they are to mistakes or to succumb to ⁓ irrationality. We're all going to have something that we're in love with that we might invest in because or got the main knowledge in that somebody else looks at and says, that's a silly thing to do. But I think that the part that you've brought to the table, you know, progressively, you know, through your career, and there's no accident in how your career has unpacked itself, from engineer to now dealing with investment data and human behavior is to help people, as you said, save them from themselves and not make these mistakes. And that's really what we want investors to do and when it becomes the advisor to do, should say when it becomes the advisors mind on the portfolio, the client's eating the advisors advice. ⁓ And that's where I always saw that some of the work I do is really important to stop that. And I think you and I need to, for as long as we can Tom, ⁓ while we also enjoy our golf, ⁓
Tom Howard: Exactly.
Hugh Massie: keep on doing this because hopefully the penny drops more and more.
Tom Howard: Yeah. So, yeah, following up on kind of the inner self, I've really become aware that through the day, I'll feel good or bad about something. And I'm feeling bad and I think, what was it that caused me to feel bad? I go back, maybe it's a story I read or a person I saw. And it really is interesting, Hugh, isn't it? How your emotions. get triggered by all these things. And if you then again let those emotions make your decisions, it turns out many of them are not particularly good decisions. You've got to have the emotions to make the decisions, but you've to have the right emotions to make the decisions.
Hugh Massie: And there's nothing wrong with being in an emotional human being, I think. Yeah, and to display emotions in the right way in certain settings, whether it's in encouraging somebody else or in a personal relationship, you can't always be cold and calculating and withdrawn, which perhaps...
Tom Howard: Yeah, well, we all are.
Hugh Massie: I've been accused of a few times, but, but, you know, you, you, you, you can't always be that, but when it, when it gets to investing, I think that, that, that, the thing is, is to really know where you are on those lines. And even if you are more the calculating, ⁓ researching type person is still emotions involved and you're still going to try and justify
Tom Howard: You
Hugh Massie: a result in something or a particular outcome because you think it's what needs to be done, but it better or decided upon but it might not be right. And and that's where coming back to really what you've been talking about today is a much more data driven approach, but also importantly, I think Tom highlighting what the amount or quantifying what the amount of ⁓ emotion is already built into stock prices.
Tom Howard: Yeah, exactly. ⁓ And people say, we're getting to be smarter. We've got a lot more data. So are we getting to be less emotional? And the answer is, maybe you've seen, I'm sure you've seen it. I think we've gotten more emotional. I'm just amazed. So I'm sitting here in Denver, in place called Dorado Greens.
Hugh Massie: Yeah.
Tom Howard: Really nice area. My golf course out just over the fence in the back. It looks about as safe as you could ever imagine. mean, the world is getting safer. The US is getting safer. And now we live in a community that's really safe. But yet people are just terrified in many cases. I almost think the safer we get, the more afraid we are. And maybe you've looked at that study there, I'm just amazed that we're moving that direction. I think we were almost less afraid back in the middle ages when it really was tremendous risk. You never knew what was going to show up at your door, that white night that turned out to be just awful.
Hugh Massie: think that's what can make a weaker society is that people get too insular and not resilient enough. And I think that's perhaps, ⁓ you know, where we've where we've got to and I think that the affluence that's in our society, and some of the the flaws that are put in place to, you know, to provide protection.
Tom Howard: Yeah.
Hugh Massie: at all levels, whether it's in the family or through the government, ⁓ create that environment. And at some point, that will correct itself.
Tom Howard: I hope so. sit here and the smallest things happening, people just go berserk. And I'm going, come on, let's kind of get this put in perspective. And I think you're right that really do lack the perspective.
Hugh Massie: But risk is also in some ways what you think risk is. know that I think it's a mindset and how you how you take it on. ⁓ And that's also, you know, ⁓ a part of it. And I think that's also ⁓ a in investment markets that it will probably always appear riskier when you don't understand it.
Tom Howard: Yeah, yeah. The example I always look back when I was growing up in the 50s and 60s, my mom would open up the door, the house at eight in the morning and say, go play. And we lived in ⁓ large metropolitan areas. Just go play and come back for dinner. And that's what we did. And ⁓ back then, the crime rate was much higher than it is today, if you look at statistics. ⁓ And then today, people are terrified that they don't have their kids on the cell phone. They have to know where they are all the time and I have to shake my head.
Hugh Massie: Yeah, I I remember when I was like seven years old, my mother taught me how to ride a bike. ⁓ And from thereafter, I was riding a bike five miles to school and back every day, know, rain, hail, shine, ⁓ to sports, all of that type of thing, you know, we were allowed to roam around the streets, my brother, younger brother, he followed not long after. And that's what you did. Whereas today, that isn't going to happen. ⁓
Tom Howard: Mm-hmm. Yeah. Yeah.
Hugh Massie: you everybody's taken everywhere in cars and you know, that's got its implications on health. And but I think also because of the media, we know so much more than maybe we than we used to, we look at human life, perhaps differently. ⁓ You know, so and we are in a way in a complex world. But as you say, I think there was perhaps more risk in, you know, the the earlier life that we had. ⁓
Tom Howard: Yeah, yeah, exactly.
Hugh Massie: So just one, just a couple of things, Tom, to wrap up. Because I think you and I can talk on these issues all day. We talked, I probably quite a lot today, you know, about more what I call retail wealth management, a little that was a little bit slant with advisors, but how should institutional investors be thinking about this? And how should maybe even, you know, the, the wealth managers out there, advisors and the
Tom Howard: Okay. Forever. ⁓
Hugh Massie: individual investor understand the mindsets of institutional investors in this area of ⁓ managing emotion and how portfolios are built.
Tom Howard: The few thoughts on that. ⁓ Let's take the hedge fund industry, for example. And we see this in mutual funds too. It turns out that the smaller hedge funds and the smaller mutual funds perform better. But the big funds get all the money. And so, and that's again, an emotional, ⁓ decision that people make. If you're big, you must be good. If you're small, you must not be good. ⁓ And so that's an issue. institutions, they have to accept kind of people the way they are, which is unfortunate, but they have to. ⁓ The other thing that we see is that investors, when you underperform, they leave you.
Hugh Massie: Yep.
Tom Howard: And if you underperform for two or three years, even though you have just tremendous track record, they leave you. So what's the response of the institutions? Well, we're going to put out closet indexers. So we don't under outperform. And it's as frustrating as it could be. they're recognizing the way ⁓ investors respond on that. And we see it. And we're seeing it right now in the NFL with all the coaches being fired.
Hugh Massie: Yeah.
Tom Howard: Some of these coaches have tremendous records. So they had one bad year or one bad game and they fire. You know.
Hugh Massie: Yeah, they didn't just become bad, obviously, if their if their behavior is what I call morally unacceptable or lacks trust, that's a different issue as opposed to the team didn't overall do as well when they've got a proven track record.
Tom Howard: Yeah. Yeah. so that's, so the institutions are just in a lot of cases responding to the way investors, we'd like the investors to be, you know, more rational and so forth. Although that would do away with our business because all of a sudden those emotion premiums disappear. So I've spent, and you're the same way, I've gone all over the country for years talking about this. and in my classroom and in seminars and in conferences and so forth. How many minds do you suppose I've changed on this stuff? ⁓ You know, people just have their idea. again, from Athena's perspective, it's you know, I'd like to have everybody make good decisions, make a lot of money, but they don't make the best decisions. And we sit on the other side.
Hugh Massie: But in a way, you've you've had very successful portfolio performance on a sustained basis, particularly for those clients that have stayed in on the long term and, you know, follow the advice, you know, the right portfolio structuring, I think it's easy to
Tom Howard: Yes.
Hugh Massie: to sort of look in and say, well, Athena didn't do so well last year, but look at it in a long-term perspective, the portfolio's been well structured and people just haven't made early withdrawals, like you were alluding to at the start, then it all works. That's really the key premise is to be there ⁓ for the long-term. think it's like the work I've done on to help ⁓ and clients understand their system one natural instinctive hardwired behaviors. Has everybody bought into that or want to be bothered with it? Absolutely not. But the ones who have have been very successful, you know, over ⁓ 20 plus year period at engaging clients, but also in building the portfolios. And ⁓ know that because ⁓ I see what happens there's never been phone calls with complaints. And I think that what we have ⁓ and doing is right. You just got to keep, you you got to keep with it. ⁓ And time, you know, I think that because of the chaos we live in, this, I believe this
Tom Howard: Yes, exactly.
Hugh Massie: will bring people back to having to understand their instinctive behavior because what's going on out there is forcing you into that place. So just to wrap up, Tom, there are some ⁓ very famous pioneers out there in the field of behavioral finance. Daniel Kahneman, died a year or so ago and others. But in my mind, your work's equally pioneering and sort of how do you state ⁓ But want to sort of just wrap up by saying how what you've done and concluded upon and act on every day very consistently is different to everybody else in this field. Because I think that that needs to be celebrated more and awarded more.
Tom Howard: Well, thank you very much for saying that. ⁓ You know, again, I've said this several times during our discussion here this afternoon, but I want to get investors and advisors to be harvesting the cognitive errors, the result of the cognitive errors. And it's my job is to identify where we can build portfolios to do that. And so the more you stand on the side of harvesting versus generating
Hugh Massie: Yeah.
Tom Howard: the better you're going to be. And so that's what we try to do through the financial planning all the way up through the investing that we do.
Hugh Massie: And I think if I put it in my practical, you know, sort of nutshell way, the way in which you approach investing and actually you're actually doing it and addressing these biases to capitalize on them, as opposed to, you know, yeah, there's research on on on 200 of these biases that exist that probably if you condense it, there's there may be less and there may be more. But I think there's a lot of research about them.
Tom Howard: Mm-hmm.
Hugh Massie: no one, not very many people know actually how they play out and have gone and measured how they play out. And I think that's really what ⁓ you've gone and done to provide a very concrete, successful strategy for on them and succeeding from an investment perspective.
Tom Howard: It's been the most interesting research I've done in my entire academic career. It's very much Greenfield out here to say, I'm going to build a portfolio based on behavior. And you go, what? What are you doing? But it's really Greenfield. And I've published a lot, continue to write a lot, and very much enjoying it.
Hugh Massie: Well, that's the thing, you you've got, I can tell you enjoy it and love it just going ⁓ Tom. And this going continue to grow. And I hope to and participate that as well. ⁓
Tom Howard: Well, thank you very much, Hugh. I thoroughly enjoyed our conversation.
Hugh Massie: Thank you, Tom.
