Crosby, The Behavioral Investor

In 2014 Daniel Crosby, a psychologist and asset manager, co-authored the bestselling Personal Benchmark: Integrating Behavioral Finance and Investment Management and followed that up in 2016 with The Laws of Wealth. Another two years and he’s produced a new book: The Behavioral Investor (Harriman House, 2018). His “admittedly audacious” goal is for this book “to be the most comprehensive guide to the psychology of asset management ever written.” I’m not sure that he has succeeded in this task, though perhaps my hesitation comes from having read far too many books on behavioral finance and having mashed them all together in my mind. But even if he has fallen short of his own self-defined goal, he has written a sweeping account of the impediments that human beings have to overcome to become successful investors. He also points investors to a “third way” of investing, distinct from both the passive and the active approaches.

Crosby starts with findings from sociology, brain studies, and physiology—for instance, that taking financial risk causes real bodily pain. And, from John Coates’s seminal research, that during times of market volatility “the cortisol levels of traders increased a whopping 68% over a period of just eight days!”

In the second part of his book Crosby tackles four main issues in investor psychology: ego, conservatism, attention, and emotion. One takeaway from the chapter on conservatism is that, “holding outcomes equal, action is more likely to lead to regret than inaction.” So, even when action is called for, we tend to do nothing.

Part three looks at what it takes to become a behavioral investor. Let’s revisit the problem of conservatism. One of the ways we can surmount this problem is, oddly enough, to procrastinate. In a research study “subjects chose the default option 82% of the time when asked to decide in an instant, but only 56% of the time after being given a short delay.”

In his chapter on honing attention Crosby argues that “an investable factor [and he highlights the factors of value and momentum] must be empirically evident, theoretically sound and have roots in behavior.” He claims as a fact that “data without theory and theory without data both produce spurious results.”

The final part of the book analyzes how to build rules-based behavioral portfolios. The process includes an element of market timing, “infrequently taking risk off the table when the market is poised to do its worst.”

Crosby’s book is eminently readable, with ample stories and studies. Here and there we find howlers, such as his claim that Thales was a contemporary of Aristotle, just a little less egregious than my saying that I am a contemporary of Sir Isaac Newton. But the book offers the reader valuable lessons in creating a portfolio that can, at least in part, circumvent the most pervasive behavioral pitfalls.