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 Shani Jayamanne: Welcome to another episode of Investing Compass. Before we begin, a quick note that the information contained in this podcast is general in nature. It does not take into consideration your personal situations, circumstances or needs.

Mark LaMonica: So today is another episode where we have a special guest, which is always exciting, Shani. So, we have Dr. Ryan Murphy, Global Head of Behavioral Insights at Morningstar. Ryan is very accomplished. He has a PhD, hence the doctor, and a postdoc in decision sciences. He has been a professor at the University of Zurich and worked for various companies throughout his career focusing on decision theory.

Jayamanne: Ryan has been at Morningstar for about seven years and his team spends their time helping individual investors and advisors understand the "you" part in investing. It's about understanding why investors make the decisions that they do, often to their detriment and practical ways for investors to reduce the likelihood of making decisions that will hurt their outcomes.

LaMonica: And more importantly, Ryan is a master of what we like to call the Morningstar Voice. His research and specializations are extremely complex, but he has a special skill in making his research make sense for everyone and communicating the findings in an engaging and thoughtful way.

Jayamanne: And today, we've asked him to come onto the podcast and speak about some of his latest research that revolves around goals-based investing and digging deeper for goals.

LaMonica: It is research that he has conducted with his team. The research delves into the fact that understanding and defining your goals isn't always as simple as just asking and reflecting on what you're trying to achieve. And sometimes it requires a little bit more work and digging to truly understand what you were trying to achieve.

Jayamanne: And the research explores how to access these deeper goals and in practical ways that you're able to do this yourself.

LaMonica: And we've spoken before on the podcast about why properly defining your goals is important. Understanding your goals, truly understanding your goals means that you're able to build a portfolio that is there to achieve those goals. Having a portfolio that is built around goals means that you have a North Star, something you are trying to achieve that will guide you through market volatility, bear markets, bull markets, all the uncertainty that we all face.

Jayamanne: It's about increasing the chances that you'll stick to your plan. So, we're very excited about this episode. It's one that we think listeners will get a lot of value out of. We certainly did.

LaMonica: All right. So, Ryan, thank you very much for joining us today. Before we get into the topic, and we're going to talk about goals today, we thought maybe if you could give a little bit about your background, your current role at Morningstar, that just be a good introduction for everyone listening.

Ryan Murphy: Sure. Of course. Well, thank you for having me here. So, I'm the Global Head of Behavioral Insights. And so, I and other researchers, I was part of the group study how people make decisions about risk and money and investing. So, this is an interdisciplinary undertaking, drawing on psychology and economics, but all of it very much applied to try and understand how we can use those insights to help people make better choices.

LaMonica: All right. Great. And as I said, we're going to talk about goals and we're going to talk about a specific piece of research that you put out called Digging Deeper for Goals. But I think before we get into that – and it is something that we talk about a lot on the podcast, but maybe just an overview of why it's so important to use goals as a crucial building block in creating a portfolio. So maybe if we could cover that first and we'll get into some of the research.

Murphy: Yeah, absolutely. So, I don't think of it as just a building block. I think of it as the focus. It's the reason that people are investing is to try and reach their long-term financial goals. And to quote the great thinker, Yogi Berra, if you don't know where you're going, you might not get there.

And so consistent with that spirit, what we're thinking about is, all right, well, why are people investing? Investing is hard. It's not a natural thing for people to do. It requires patience and discipline and being able to embrace uncertainty. And there must be a reason they're doing all those things while they're trying to serve some sort of longer-term, large, overarching long-term financial goal. And so being able to articulate that at the beginning is, I think, paramount to a successful investment plan. That's the whole way in which we can evaluate success is, are we helping people reach their long-term financial goals?

LaMonica: Yeah. And it's one of the values of, of course, financial advice. And we know a lot of the listeners of this podcast are self-directed investors. And so, what we're trying to do is, of course, deal with a lot of those behavioral issues that people have or help people deal with those behavioral issues and put a lot of structure around what they're doing, which, I think goals are really important. And that's why this piece of research that you and the team put together, I think, jumped out at both Shani and I. And it's called Digging Deeper for Goals. So, what was the original purpose and thought process behind this research?

Murphy: Yeah, of course. So, this research builds on a piece we did a couple of years ago where we were trying to get into ways to understand how we could help people articulate their goals. And this piece digs into a little bit deeper of trying to help people understand and articulate their why, why they're investing. So, for example, if you start off by asking people what their goals are, they might say something like retirement, which is true, but it's not all that useful, not very deep. You push a little bit further and they say, okay, something like a safe and secure retirement, right? Now we need to get into the details of what precisely that means and how to serve that. But then you can start to get even deeper. It's like, well, what does that entail? Part of what they want is more time, more time to be able to spend with family and friends. And so, what are the things they need to do now to be able to have the resources to facilitate those longer-term, deeper goals, not just safe and secure retirement, but the things that give them meaning and purpose during that decumulation phase.

LaMonica: Yeah. And I think it's interesting because as you said, you spend a lot of time in this research that you put out, talking about surface goals and deeper goals. And I think my experience is when I talk to investors, generally what they'll say, and you use retirement, which I think is a nice example, I just hear all the time that I want to be rich, or maybe if they don't exactly want to come out and say that, I hear a lot, I just want the most money possible.

Murphy: Right.

LaMonica: And so, yeah, maybe it'd be interesting just, yeah, let's talk about, maybe dig a little deeper into sort of those surface goals and deeper goals. And I think really the process, and you talked about it a lot in the research, and the research was directed, I think mainly, or will be used mainly by financial advisors as they work with clients. But the process from going from surface goals to deeper goals. So even if you're a self-directed investor, you can get to those deeper goals that can inform what you're doing with your portfolio.

Murphy: Yeah, absolutely. And so, one of the surprising findings from the research was that when we asked investors what their goal was in investing, we found that about 25% of people gave unreliable answers. Now, I don't think that they were lying or trying to deceive. I think that's just a very difficult question. It looks like an easy question that should be simple to answer, but it's not so easy. It turns out that if you start to give people a little bit more of a framework to think about what goals can be, and so for that part of the research, we use a checklist showing investors what are typical goals that people might be aspiring towards. And just going through the checklist and having people identify what really appeals to them, or what doesn't appeal to them, that process gives them a little bit more time to reflect. And after people have gone through that process of using the checklist, and then you ask them, okay, what are your long-term financial goals, many people give different answers. In fact, we found that about 75% of people were changing at least one of the top three things they said they were investing toward.

So, this is evidence that people are a little bit strangers to themselves. They just may not know – and more perniciously, they may not know that they don't know. And this is a hard problem. How do you help people make a good decision and understand their own motivations when they have trouble even seeing these things themselves? So, there's this tremendous value that comes with using these checklists and that comes out of this research that any investor can use themselves to go through and start to better understand what their motivations are. I mean, if anything, the finding was so surprising because it's such a simple question, of course. What are your goals? People should know this. And it's not that people are dumb. That's just not where most people's attention is on a day-to-day basis. People are thinking about what's for lunch or where's my cell phone, these sorts of things, not what are your 30-year overarching long-term financial goals. That's a hard question.

LaMonica: Yeah. And I guess what are some examples or maybe just talking about going through this process, how did people's goals change and where did they land? What were some of those popular answers? You say there's a big difference between surface goals and then when they've gone through this process, those deeper goals. What are some examples?

Murphy: Yeah. So, a lot of people would say things like retirement. Okay, that makes sense. But then you start to push a little bit further to see what are they looking for, right, and to have more time too. And we saw that answer a lot, but the more time to do what, that varied wildly by people. And it was really interesting to see some of the responses were really quite touching. People talking about how they'd given up their interest in music in order to have a career to support their family. And now that they had more time, they wanted to go back and start to get back into their music or their art or other sorts of passions that they had that they set aside for pragmatic purposes.

You'll hear what we would see people say things like to pay off a mortgage. Okay, that makes sense. But then when you push a little bit deeper, why do you want to do that? Well, we want the free resources to buy a cottage as a secondary home that can be our retirement home. And that's what we want to move toward. Now notice how much more specific that is. And how that really is a much more satisfying long-term goal that people would have.

We would see people on the superficial side, things like incidentals. I don't really know what incidentals means, except that people anticipate they'll have bills in the future, which yeah, I think it's a reasonable conjecture. But then you push that person a little bit further, and they'll say things like not to be a burden on my children. Now that's a really deep meaningful that comes from, I think, a very meaningful psychological place and what experiences this person might have had that would lead them to feel this. And that I think can be really worth knowing as a person is trying to articulate and understand what their goals are.

I want to be rich. Doesn't do that, right? It's not specific. It's not actionable. It's not measurable. But starting to think in a serious way, what do I need to do today to be able to set myself up to buy this cottage as a secondary home, or to have more time to do art, or to make sure that my children don't have to be responsible for me and my wife.

LaMonica: Yeah. And I think the thing that I always find interesting when I hear that I want to be rich is obviously there's no definition of rich. It probably is very different in everyone's mind, but also like rich to do what, right? They're trying to obviously enable something.

Murphy: Exactly.

LaMonica: Yeah. I think you certainly captured that with some of the examples that you put through. So, if we look out at just investor behavior and obviously the impact that that has on investing, and we see this all the time, a lot of the work that you and the team have done, all of the work around behavioral finance, how much we are actually impacting our own outcomes just by these ingrained biases we have, how would a rationality fit very specifically into this goal-setting process?

Murphy: Well, I think that what we're trying to do is help people make choices today that put them on track to where they want to go longer term. And one of the most valuable things people can have as they approach this problem is be able to understand the frame of reference that's useful to this. So, for example, how are you doing? Well, the natural follow-up question that is well compared to what, right? And so, if people are using their compared to what is what did the market do yesterday? Then they're going to have a very strange kind of path as to what they're doing, right? Because are they trying to beat the market? The market is of course going to go up and down. Do they have a portfolio designed to outpace the market? That could be a very volatile portfolio. And there's no guarantee that that's actually going to get them closer to their goals, right? Notice how goals are not entering into this.

And so, one different way to frame this then is to flip it. Say, how am I doing? Well, am I on track to reach my long-term goals? And just that reframing of the process and helping people focus on what matters can help them avoid the kind of bad behaviors that we see naturally emerge. So, for example, return chasing is a common thing we see where people overreact to what the market just did. That's not going to help people get towards their long-term goals. Whereas if you help people take a much longer-term view, think in terms of market cycles, 15, 20-year investments, then they start to behave. The thinking is that they'll behave much closer to rational rather than fall prey to some of the mistakes that we know people tend to make.

LaMonica: Yeah. And we see this all the time. I think research that's also put out by Morningstar that we talk a lot about is this Mind the Gap study, really looking at obviously the difference in returns that investors get versus investments. And that gap, a lot of it is attributed to, of course, chasing returns. And I think if you have this surface level goal of, I want the most money possible, then maybe it makes sense that you're continually turning your portfolio and trying to get into better-performing investments. Even if intellectually you know that that's not a great approach to take, I think people fall into that trap, which is why we've always talked about goals-based investing and I think this is a great way to think about how do you make those goals, that goal setting process better and improve it.

Murphy: Right. I think getting that right at the center of where people's attention is is a rather useful way to try and nudge people to make better decisions. So, we know a lot about the psychological biases that people fall prey to, and that research has been existing since the 1970s or so. And initially when it was discovered, there was an effort to say, well, why don't we just make people aware of this and then teach them, teach them not to make these kinds of mistakes. Don't chase returns. Don't be hypersensitive to losses. Don't be risk averse. These sorts of things.

Turns out that is uphill. That doesn't work really well in getting people to make better long-term choices. So rather than just throw up our hands and say, well, people are hopelessly irrational, can't do anything about it. There's been a change in the how we thought about this intellectually. So, there's this notion called choice architecture. Rather than try and teach people to be rational, we start to think about how can we structure the choices and the decisions that people face in a way that can help them make more rational choices. And this idea of using goal framing as the foundation for why people are investing is a kind of choice architecture. Shifting their attention to thinking the longer term, think about their goals and answer their why rather than what did the market do yesterday, what's the hottest asset class, where can I go chase returns. So, all of those are bad sorts of things that persist. I mean, Mind the Gap study is an excellent example of the persistence of these biases. And rather than just tell people, this is probably not going to serve you well, there's ways to nudge people to make them more aware of what they should be doing today and then ultimately make better choices.

LaMonica: And so, if we think about – and as I mentioned earlier, I think a lot of this research that you're doing is obviously helping financial advisors work with their clients and define these deeper-level goals. But are there some practical ways that maybe a self-directed investor can go through this process? You talked about how challenging this is and how challenging it is when we're preoccupied by all the little things going on in our lives. But what are some ways that investors can dig deeper and try to define these deeper goals?

Murphy: Absolutely. So, I think as they dig deeper, it's worth trying to figure out why are they investing, right? So, what are they trying to accomplish? What are the long-term goals that they are setting themselves up for? The biggest driver of investor success is not picking the next hottest stock. That's not a reliable investment technique. What is for the individual investor is to make sure that their contribution and savings rate is sufficient to get them where they want to go. Once we make sure that people are saving enough, and then after that, once they're investing, then to make sure that they're invested in something that's broad-based and gives them the kind of expected returns that's necessary to get them where they want to go. People sometimes don't think very carefully about the time scales at play here and the pernicious effects of inflation that money is losing value just as time ticks away. And so, they have to make sure whatever their investments are, are at least outpacing inflation and their capital is actually growing in terms of its purchasing power.

LaMonica: So, Ryan, we've obviously talked a lot about the goal process. And you mentioned why it's so important to have goals because then you can measure success against those goals rather than how an index performs, for example. But if we think about that process of diving deeper, getting past these surface goals into deeper goals, what is a way that an investor going forward can measure success and make sure that they're on track to achieve those goals?

Murphy: So, I think that there's a math problem then where you're connecting the heart and the head. So, the heart here is to be able to have time, to be able to spend more time with family and friends during retirement. Okay. So, then you have to start to be more detailed. What is that going to entail? Here's the expected cost of living and so on for that's going to be. So, you might map that out in today's real dollars, but recognizing that inflation is going to continue to churn away. And so that whatever investments you would have, would have to outpace that plus grow to be that kind of target thereafter. This is a complicated math problem, but it's tractable. Once you know what you're trying to aim for, what the capital requirements of that would be, then starting to back out what you need to do today to be able to have a good chance of getting there.

LaMonica: Great. That's great, Ryan. So, I think we'll probably just leave it there. But I think the message to everyone listening is obviously people are listening to an investing podcast. They're probably pretty interested in investing. They're investing their own time to learn more about investments. But I think the key takeaway to me is that spending time thinking through those outcomes that you actually want to achieve is seemingly the most critical part of this whole process and that investing that time is really important to make sure you achieve those outcomes.

But I did want to thank you, Ryan. Really appreciate you taking some time, sharing your insights from the study and then the work that you and the team have been doing around behavioral finance. So, thank you very much. I appreciate it.

Murphy: Of course. My pleasure. Thanks for having me.

LaMonica: And thank you everyone for listening. As always, we appreciate any comments or ratings in your podcast app. And thanks very much for listening.

(Disclaimer: Any advice in this podcast is general advice or regulated financial advice under New Zealand law prepared by Morningstar Australasia Proprietary Limited and/or Morningstar Research Limited without reference to your financial objectives, situations or needs. You should consider the advice in light of these matters and any relevant product disclosure statement before making any decision to invest. To obtain advice for your own situation, contact a financial advisor.)

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