Book Review: The Laws of Wealth by Daniel Crosby

The Laws of Wealth shows how our irrational behavior can get in the way of wise investing.

As a behavioral psychologist, Daniel Crosby identifies key human weaknesses that can sabotage our investments, such as overestimating our abilities and panicking in the face of risk.

He then presents practical and effective strategies we can use to become better investors.

You may be wondering if you should read the book. This book review will tell you what important lessons you can learn from this book so you can decide if it is worth your time.

Without further ado, let’s get started.

Lesson 1: Emotions influence our decision-making ability

Who doesn’t enjoy crying while watching a sad movie or feeling ecstatic when they fall in love? Extreme emotions abound in life. When it comes to investing, extreme emotions can interfere with your decision-making abilities.

Jennifer Lerner, a social psychologist, conducted a study with two groups of participants. One group was assigned to watch a sad scene from a movie and then write about it. The other group was shown a boring video clip about fish. They were then required to write about their daily lives.

In a second behavioral experiment, the researchers asked the same participants to pretend they were buying and selling pens. A lack of strong emotions was associated with good decision-making. Sellers in the group who watched the boring movie were far more astute in determining how much to charge for their pens.

Overall, the group that watched the sad movie paid 33% more than the group that watched the happy movie.

A sad investor is a potentially gullible investor. What about positive emotions like elation?

The subject of Dan Ariely’s 2009 book Predictably Irrational: The Hidden Forces That Shape Our Decisions was an experiment designed to assess the effect of excitement on decision-making. During an interview, he asked students about their sexual habits, including “Would you cheat on your partner?” and “Would you have sex without condoms?”

Initially, most students said “no” to both questions. The researchers then showed pornographic images to the same group of students. They then asked the same questions again, with unexpected results.

Students revealed that they would be 136% more likely to cheat on a partner and 25% more likely to engage in unprotected sex after viewing the images.

Because of their enthusiasm and excitement, these students had become more daring. They lacked the ability to practice restraint in the heat of the moment, despite knowing that their behavior was irresponsible.

Investing and their behavior have numerous parallels. Investing, on the other hand, is not like watching porn! Winning such high-stakes deals, on the other hand, can be emotionally draining.

It has been demonstrated that both positive and negative emotions can influence your decision-making abilities.

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Lesson 2:  A good investment decision is to hire an advisor

Investors may know all the rules in their heads. After reading a gazillion books, they may have learned that planning and avoiding impulse purchases are essential. However, simply knowing does not guarantee success.

It is for this reason that you should hire a professional advisor. Advisors have been shown to play a crucial role in helping investors make better investment decisions and stick with them.

Financial returns are substantial as a result of this assistance. The financial analysts at Morningstar estimate that investors who use advisors outperform other investors by 2 to 3 percent annually.

During a crisis, advisors can provide important support. Imagine having invested all of your life savings only to see the market collapse during the financial crisis of 2008. Any investor would have gone crazy.

Following the crash, most investors struggled. According to financial consulting firms Aon Hewitt and Financial Engines, investors who received assistance during the critical years of 2009 and 2010 actually outperformed other investors by 2.92 percent.

Advisors don’t just provide their clients with statistics and probabilities to help them weather difficult periods. Advisors who provide their clients with behavioral coaching also act as reality checkers when it comes to their emotional decisions.

Advisors can, for example, act as devil’s advocates when it comes to evaluating investment decisions. You can think through every possible problem with an investment by asking yourself a lot of challenging questions. 

You may not feel like doing this when you’re full of enthusiasm, but it could save you major losses. In the event that the potential investment survives the pre-mortem, then it could be a winner!

Some advisors are better suited for your needs than others. Before hiring anyone, make sure that you ask them about their credentials, investment philosophy, and communication style. It’s crucial that, along with investment advice, she’s also good at behavioral coaching. The most value comes from this.

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Lesson 3: Don’t worry about investment panic

Imagine investing part of your life savings in a company, only to find out that the company is under investigation for fraud. This would likely fill you with fear.

As an investor, you will be bombarded with information by media outlets in search of scandal and disaster. In case you are not careful, such reports may unduly influence you, leading you to act out of fear instead of good judgment.

Catastrophizing is a tendency among humans. This means that whenever you hear something alarming, you immediately start imagining the worst consequence that could occur. 

Did you hear your stock take a hit? The next thing you know, you’re probably picturing yourself living on the street and being dependent on your grown children.

It is quite normal for your stocks to lose value from time to time, even though the media portrays every dip in the stock market as an alarming crisis. 

Stock prices can sometimes be overinflated, causing people to sell their stocks en masse to profit from the high prices. 

The stock value plummets, sometimes losing more than 10 percent of its value. It happens approximately once a year and is called a correction.

You don’t have to worry about these dips affecting your stock portfolio in the long run. However, if you immediately sell your stocks, then you’ll be losing money since you’ll be selling them at a loss.

Our fear is highest when the market is actually at its safest. You may feel very confident at a time of great prosperity, but high valuations are a sign of a bubble. 

Despite feeling terrible after a price drop, the drop represents a safe market because it reflects a more accurate valuation.

Be careful not to jump at the first sign of trouble. As an investor, you need to be prepared to weather market tremors.

Lesson 4: Learn how to identify a dubious organization by evaluating what its management does rather than what it claims

There are many cautionary tales about Wall Street con artists. No one wants to be duped into investing in the next Ponzi scheme. Yet, how can we avoid becoming the next Bernie Madoff?

Our instincts and powers of detection may lead us to believe we are able to distinguish a con artist from a genuine one. We are terrible at detecting lying, according to research.

Psychologists Charles Bond, Jr. and Bella de Paulo analyzed 200 studies on how people detect lies in a paper published in Personality and Social Psychology Review in 2006. 

In their study, they found that only 47 percent of the time people were able to detect lies based on their body language. Therefore, flipping a coin would provide greater insight into who is lying than analyzing their behavior.

Liars can be hard to detect even for those with expert training. An experiment was conducted in a prison to test the ability of law enforcement professionals to identify a true confession from a false one. It was only 42 percent successful!

As investors, how does this affect how we decide whether we can rely on the leadership of a company? Simply put, we must stop listening to what the executives are saying and start looking at what they are doing.

The way they invest their own money is especially important to look at. Managers of a company have the most in-depth information possible about their own business. Is that motivating them to invest in their own stock? Or do they want to sell it quickly?

Tweedy, Browne, an investment firm, published a study in 1992 showing that companies with significant insider purchases outperformed other companies on the stock market. Their stock prices rose two to four times more than other companies during the same period. An insider’s bet on a company is likely a very good bet indeed.

You can easily determine whether leaders are telling the truth about their companies by looking at where they invest their own money rather than fighting a losing battle. You can always tell by their actions rather than by what they say.

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Lesson 5: Investing isn’t always about getting the highest price, so focus on value instead of glamour

Is it worth $52 to buy an old, burnt oven mitt? Imagine learning that this oven mitt once belonged to none other than Julia Child, who burnt it as she prepared her first beef bourguignon?

If you were to acquire something with such an interesting and historically significant past, you might be much more likely to reach into your pocket to acquire it.

We have to keep in mind that we can be irrational when we buy stocks. Most of the time, we believe that a product is valuable just because it is pricey instead of evaluating it based on its merits.

Stanford University professor Baba Shiv used an fMRI machine to measure the brain activity of participants while he fed them droplets of wine. He told them some bottles of wine cost $90 per bottle, but others only cost $10. 

When people were told the wine was more expensive, the pleasure centers in their brains lit up much more. Nevertheless, all of the samples were the same, as you might expect. Their enjoyment of the wine was enhanced simply by believing that it was more expensive.

When it comes to buying wine, assuming that price is the same as quality may not seem so problematic, but if you do that with stocks there can be disastrous consequences.

Glossy stocks are usually issued by start-ups and companies in rapid growth. Their value rises rapidly and they are very attractive to investors. Buying those stocks at the height of their popularity, however, may not be profitable. 

When the bubble bursts, you could lose money in addition to paying a lot of money for something that won’t increase in value significantly.

You need to invest in value stocks if you truly want to make a sensible investment in the stock market. Stocks like these are often considered unpopular because they often come from smaller companies without much brand recognition or social cachet. 

Certainly, they won’t command the highest prices. Therefore, they have room for appreciation. Due to the fact that you bought them at a fair price, your investment is much less risky.

It is counterintuitive to pick a value stock, similar to choosing a lanky, popular basketball player over the popular, lanky one who scores frequently. 

While glamour stocks soar and then crash, unpopular kids might surprise you by putting up a steady and solid defense, and value stocks may live up to their name, quietly gaining ground as glamour stocks soar and crash.

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Lesson 6: Don’t get seduced by exotic investments

During the early 1600s, the Dutch became famous for their tulips. Its exotic shape and beautiful color astonished people who had never seen a flower of this color. The tulip became a symbol of status. 

The price rose along with the demand. Suddenly, people were willing to pay up to ten times a worker’s annual salary for just one bulb. A tulip frenzy crashed spectacularly in 1637, the end of what is thought to be the first speculative market bubble.

The new and exotic evokes such great enthusiasm, so what is it about them? Tulip bubbles have been repeated time and time again in economic history.

There were many casualties during the dot-com bubble, which was much more recent. The internet seemed to offer so many opportunities that any investment ending in .com seemed like a sure thing.

A company called, founded in 1997, attracted an investment of $8 billion by 1998 despite only reporting $30 million in toy sales. Comparatively, Toys “R” Us only invested $6 billion in their conventional, “boring” toy company. 

Additionally, they had a website, but as they were seen as traditional and old-fashioned, investors weren’t enthusiastic about them.

In 2001, filed for bankruptcy, and was later bought by Toys “R” Us. Due to their excitement, investors were unable to make a rational evaluation of the company.

Similar stories can be found in the aviation industry, which is synonymous with exoticism and excitement. Air travel allows travelers to complete a journey that could have taken weeks by ship in a single day. Innumerable changes have taken place in how we live, work, and think about the world.

Investing in this industry for the purpose of making money, however, has never been a good idea. Historically, investors in air travel have lost money due to high fixed costs, strong labor unions, and rigid pricing models.

We should all remember to keep that beautiful, exotic tulip in mind when we are tempted to invest in something exciting and new. It’s beautiful to look at, for sure. But what lies beneath the surface? Are you really going to pay ten times your annual salary for it?

Lesson 7: Investing money should be based on our own personal goals

What is the right amount of money? There are so many ways of answering that question. Financial independence can be achieved by saving ten times your annual income. 

It’s also possible to compare yourself to your neighbors and decide that you will be doing well once you own a fancier Ferrari than them.

Instead of looking outwards, the best way to answer that question is actually to look inwards. 

We all have a “hierarchy of needs” that determines what’s important to our happiness in life. Individuals’ personal needs can vary greatly even after they have met obvious human needs like food and shelter. 

For some people to feel secure and be able to afford a college education for their children, they need a lot of savings. 

For others, having ready cash at hand is far more important to support trips such as traveling the world.

Based on these values, you will decide how to invest. Maintaining your mental health in the midst of the market’s turbulence requires that you understand this benchmark clearly yourself.

For example, if you know you’ll need access to your savings in 15 years, you won’t be so worried about every dip in the market because you know the stock market value will recover over time. 

In contrast, if you are supporting an aging parent with unpredictable health care costs, you require an investment plan that is less risky in the short term and allows you to access money quickly when needed.

How do you ensure that your financial decisions match your goals? You can start by changing how you talk about money. Barack Obama and his advisors knew the power of language very well when they decided to label the money that was injected into the economy as a “bonus.” This encouraged people to spend it immediately, instead of saving it.

Behavior psychology can be used to our advantage if we define explicitly what our savings and investments are for. 

One study showed that low-income families were more likely to set money aside for their children’s college education if they put the money in an envelope with their child’s picture on it. Knowing why we invest our money is motivating.

Make sure that any investment you make aligns with your goals and dreams by considering your own needs and values before making it.

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About The Author

After completing his Ph.D. in psychology at Brigham Young University, Daniel Crosby moved into finance and became an expert in understanding how emotions and behaviors affect investing decisions. 

Previously, he coauthored Personal Benchmark: Integrating Behavioral Finance and Investment Management, a New York Times best seller. 

He is also the founder of Nocturne Capital, an investment management firm.  

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