Practice Makes Perfect: Building a Well-Behaved Portfolio

GREG HALL: Hey, everybody. Welcome to another episode of Accrued Interest PIMCO's podcast dedicated to serving financial advisors, their clients in the wealth community at large. As always, I'm your host, Greg Hall. I lead the wealth management business for PIMCO here in the United States. I'm really excited about today's episode. We've been wanting to do this for a while.

We have here at PIMCO been very careful over the last few years to try to embed the principles of behavioural finance in our own investment decision making. We all approach problems with biases and prior convictions and preconceived notions, which can color the way that we think about the decisions that we make along the way to invest in capital on your and your client's behalf. And understanding those biases, having tools that help us work around them or mitigate them as we make those decisions.

It's incredibly important to us, you know, to question, you know, what might be influencing our own thinking. And so, as part of today's podcast, really really fortunate to be joined by Anastasia Buyalskaya. Anastasia has really become part of the PIMCO family. She is an assistant professor at HEC Paris, not HEC Paris. I've been informed, HEC Paris.

She's a consultant, an advisor to PIMCO on topics of behavioral finance. She has been embedded in our investment decision making process. She presents to us at our quarterly investment forums. She has co-authored or ghost authored our macro signposts column, which is typically written by Tiffany Wilding. Many of you subscribe to that and read it. It's terrific, terrific piece if I do say so myself. And she's just invaluable to us here at PIMCO.

So, Anastasia, thank you for being part of the podcast with us today, and thanks for the next 45 minutes to an hour or so of sharing your insights with the advisors listening.

ANASTASIA BUYALSKAYA: Thank you very much for having me on, Greg. It's good to see you.

GREG HALL: And then also joining is Devin Ekberg. Now Devin is an SVP, Senior Vice President here at PIMCO. And he is one of the senior folks on our advisor education team.

He's really got tremendous expertise in a bunch of topics, including behavioral finance and how that influences advisor behavior. And so, he's located in Colorado because I think it's basically the only place you can get to everywhere in the country in a three-hour flight. Right, Devin?

DEVIN EKBERG: Yeah, it's pretty much central, so I can get anywhere with a direct flight, that makes a huge difference.

GREG HALL: Anastasia, maybe you could kick us off with a quick intro to behavioral finance and then a quick intro to yourself. I'd love to learn more about, you know, how this came to be your passion, your choice of study and what interests you, you know, to this day.

ANASTASIA BUYALSKAYA: Sure. Well, I think a lot of your listeners will be familiar with behavioral finance. It's sort of been around for quite some time. I would say that the field really started in the 1970s with the publication of Prospect Theory, which is a paper from Daniel Kahneman and Tversky, which then really opened the floodgates to this field, this field that we now call behavioral science or behavioral finance when it's applied to financial decision making.

And it arose from the observation that the way that people make decisions wasn't always consistent with how economists modeled decision making. So, you know, we have this expected utility theory, which makes all these nice assumptions around how people treat losses and gains, for example. And when you actually went into the wild and you asked people to make decisions, kind of very simple decisions that maybe mirror some of the more complicated financial decisions that your clients make, it turns out, you know, people were incredibly loss averse, their risk preferences changed depending on the context that they were in.

You know, the reference point with which they were thinking about losses and gains completely changed their evaluations. So, all of these observations eventually led to the publication of Prospect Theory. And that were …

GREG HALL: Were these all the data points that sort of, you know, when at least when Devin and I were, I think we're a little bit older, you know, when we took Econ 101, you know, the myth of the perfectly rational actor always making the optimal decision, assuming kind of total information and all the lines were straight or like beautiful curves. This is sort of the debunking of that myth.

ANASTASIA BUYALSKAYA: Exactly. It totally debunked that myth. And I also was taught that, and I think a lot of students are still taught that. And so, when it, you know when Daniel Kahneman won the Nobel Prize in 2002, and then eventually wrote Thinking, Fast and Slow, I mean, 2011. I ate that up. I read that book. I think I just didn't do anything else except read that book until I had read it, because finally somebody was explaining a much more accurate model of how people were really making decisions that accounted for human flaws and biases.

GREG HALL: I'm just, I'm smiling because I'm thinking like the average financial advisor listening to this podcast is probably chuckling to themselves just thinking like, could have told you that 40 years ago, you know, 30…

ANASTASIA BUYALSKAYA: That’s right. Yeah.

DEVIN EKBERG: Well, it's actually a little bit worse than that. Like, so Modern Portfolio Theory has its origins in the 1950s with Harry Markowitz. He also won a Nobel Prize, and he's the one that created, you know, the expected value calculations, the mean-variance optimization. That's what everybody learned in business school. And that's actually the basis of investment management today. Every asset management firm in the world uses some element of modern portfolio theory to construct their portfolios and so forth.

It wasn't until the 1970s that we started to figure out, like you said, Greg, that people don't really act in that rational behavior all the time, right? We're not utility maximizing individuals all the time. And so now there's this balancing act between kind of the mathematical exercise of investment management and the human side of investment management. And if you're ignoring one or the other, you can end up with some pretty terrible outcomes.

GREG HALL: Wow, Devin, that's great context. I don't mean to simplify, but I love that for this conversation, you know, we have the academic side incredibly well represented, and the practical applied side of the science incredibly well represented. Anastasia, you said, when you got Kahneman's book, you were drawn to it. You know, it spoke to you and you devoted yourself to it until you'd read the last word. What in your kind of experience to that point had primed you to see in that book the answer to questions you'd been asking yourself?

ANASTASIA BUYALSKAYA: , It was published in 2011, so just a couple years after the global financial crisis. And I started my career just before the global financial crisis. So lived through it. I think all of us that lived through it, you know, you can't go through something like that and not have it change you. Thankfully, I wasn't managing P&L. I was very much a fly on the wall sort of just starting my career. But certainly…

GREG HALL: You were on Wall Street though at the time, right?

ANASTASIA BUYALSKAYA: I was, yeah. I was on the trade floor at the time. And you know, it's just all these illusions that I had around the fact that when you're an expert and you have this very clear financial model, then there's pretty much very little uncertainty in the decisions being made that those illusions were totally popped.

And so, the interests that I was starting to develop around even experts with really excellent analytics and really robust engines are still making decisions under uncertainty, and they still are subject to bias. It certainly primed me for then you know, as I said, being really excited about reading that book a couple years later.

GREG HALL: Can we talk about some of the common biases things that you often see in decision making processes?

ANASTASIA BUYALSKAYA: Yeah, I mean, one of the things that's happened since the 1970s is now, we've got great academic research on over a hundred biases. So, there's a lot out there. I think it's important to know that we don't need to sit down and memorize, you know, a list of a hundred plus biases, but there's definitely a core subset that we probably need to know. I'd be curious if it's the same subset that Devin speaks to advisors about. I mean, the one that you hear Dan Iverson talk about a lot is overconfidence.

So, anybody that's an active manager by nature is out there trying to beat the market, right? It's almost the definition of overconfidence. So, being really clear on having an attribution system that allows you to separate skill from luck, being incredibly clear and wary of areas of skill and reining in overconfidence on areas where you don't, I think is incredibly important. Things like confirmation bias, I'm sure we'll touch on AI, but that's something that has been around for a long time. It's becoming, I would say, a greater risk now in the age of AI, you know, investors…

GREG HALL: Is when you see in the data what you wanna to see, is that a decent distillation.

ANASTASIA BUYALSKAYA: Yeah, exactly. So, there's sort of two definitions of it. One is you go out looking for data to confirm your prior. So, I'm actually gonna cherry-pick data maybe to confirm my view, and it's not gonna be a representative subset of all the data available, or I'm actually looking at the same piece of data as you are, but I'm interpreting it in a different way because of the perspective that I have in the world. So that's confirmation bias. And again, it's been around for a very long time. I think we see it in terms of the primary resources that people look at. So, you know, if you talk to an investor, they're much more likely to send you the sell-side research that supports their view, right? That supports the positions that they have on in their portfolio. And they're not really gonna send you the stuff that has the opposite view. Same with individuals. So, you mentioned groupthink. When we think about the individuals that we bring into our teams or that we have in committees, it's probably much easier to hear from individuals that share a very similar worldview. So that confirmation bias, I think, is embedded in many different aspects of the investment process.

DEVIN EKBERG: I think the last time I read— I think academics have identified something like 150 different biases and have tested these. These are repeatable circumstances when people make these types of decisions. I think it's useful to try to categorize them in a couple of different ways. You know, Anastasia mentioned Daniel Kahneman, who's a little bit of a pioneer in this area.

And, you know, he said that we kind of have two different parts of our brain, kind of a System 1 and a System 2 part of our brain, and some of those biases sort of result coming from that, that System 1, the part of the brain that is, you know, governs our whole nervous system and, you know, and makes decisions almost automatically.

There's that part of the brain, which often produces, I think, those emotional biases that are sometimes very difficult to overcome. And then he also said that we have kind of this more cognitive part of our brain. This is where we receive and process information, and we have plenty of opportunities to mess ourselves up on the cognitive side of things as well.

But when we're thinking about biases, I think, at least from a practical matter, it's really difficult to identify exactly what bias is presenting itself, but it's somewhat easier to see what part of the brain that bias is coming from. And you can see that if it's a very emotional response, then the idea to overcome that type of bias might have a very different prescription than trying to overcome a bias that's coming from more of the cognitive part of the brain.

So, I think it is useful to kind of categorize it into those two areas. But Anastasia, I know that we science has kind been moving past kind of the two separate parts of the brain. They're all really one part of the brain. But I wonder if it's useful for you, from an academic perspective to kind of separate those two.

ANASTASIA BUYALSKAYA: Yeah, it's such a good question. I think emotions sort of have a bad reputation, especially in the investment world, where we think of emotions as being superfluous to the decisions. And what I was taught at Caltech, and my former professor, Ralph Adolphs, actually has a great book on this with David Anderson, which talks about emotion more as functional states.

So rather than something kind of that's distracting you, emotions are information, they serve a function, right? They're bringing your attention to something very specific. So, you know, if there's anger or sadness, typically the idea is that if it's informative to having you change something about the environment, I think it gets a bad rep because of displaced emotions. So, you can imagine, you know, anger about the debt crisis, maybe that's quite informative, actually, and maybe that shouldn't inform your portfolio allocation, but anger because somebody cut you off on the highway on your way to work probably shouldn't inform the portfolio allocation.

So, I think part of the confusion is the source of that emotion, and whether it's kind of an instrumental emotion that is something you should listen to, or whether it's completely displaced from something else in your life, in which case it does become a bit superfluous.

GREG HALL: For advisors listening, I mean, I think one of the things that I've learned from listening to Anastasia over the years is as we pick apart the emotional impact on decision making or the bias impact on decision making, there are tools, there are ways in which we can combat deleterious impacts on decision making.

And Anastasia, as you've, as you've talked about them, like, they're simple. They're approachable. They are good checks. And I always, I find them very appealing because it, you know, I always, for me, if there's a low barrier to entry on a tool or a process, that's really good.

GREG HALL: That's my own bias, right? If you gimme something that's kind of simple and easy to do, very happy to kind of work that into my habits. So, can we talk a little bit, maybe in the investment committee context, about how you think about what are the mechanisms by which you combat some of these behavioral issues? What are some of the, I hate to say tricks because I know they're not tricks, but, you know, you are trying to influence thinking. And then Devin, I'd love to hear what you have seen work in more of an advisor context out in the field.

ANASTASIA BUYALSKAYA: Yeah. So, I'm happy to talk a little bit about the investment committee context. It's a particular context because unlike individual decision making, now you're in a group setting, and so you're thinking about different types of biases. You know, again, authority bias comes up, who's the most senior person in the room? Groupthink, are we all pulling from the same sources of information, or do we have sort of diversity of perspectives here?

And I think there's a lot of good literature on why groups should make better decisions, right? There's all these nice theories on wisdom of crowds and collective intelligence, but they make a lot of assumptions around, for example, the inputs being uncorrelated, right? So, the assumption is everybody that goes into the room is pulling information from different sources, right? Or seeing the world in a different way. And that's not always the case in an investment committee as we know.

So, the key is to acknowledge that those things might be present, and then recognize that, you know, for something like authority bias, the solution is not to say, well, I'm not an intimidating CIO, and so nobody, you know, authority bias is not a problem here. I sometimes hear that from investment teams, right?

The solution is just to put some structure into the investment committee meeting such that the most senior person is the last one to speak, such that we make sure that there's airtime for more junior individuals, people that might have a contrarian perspective, such that you're using very simple surveys to get views in a quantitative manner before the meeting so that people are anchored on their own views before the conversation begins. This is something you mentioned Tiffany Wilding.

She does this very effectively in her regional committee. They will survey the whole team on a number of macroeconomic variables, and they'll look at that distribution before they start the conversation, because if the median view is also the most extroverted view or the most senior view, they're gonna have a lot of airtime.

But if we have that survey and we say, actually, we wanna hear from the people on the tails, and we wanna make sure we have a structured debate, now you're gonna have a much more I think informative and valuable conversation. So, a lot of it just comes down to putting some structure and some guardrails rather than trying to somehow bias people, which we know from a lot of research doesn't really work.

GREG HALL: Hmm. Yeah, that's, yeah, a lot of prep too. A very intentional approach to meetings. And the committee is a mechanism by which you try to arrive at an answer that has all of its own dynamics that might interfere with arriving at that answer. You've got strong feelings on committee size. And I'd love to explore that for a second before we move on to Devin.

ANASTASIA BUYALSKAYA: I do, there's a bit of literature on sort of governance and the right number for governance. And what I have seen is that committees can get too big very quickly. And so, the magic numbers that I always talk about are three, five, and seven. Odd numbers work quite well because you have a tie breaker. So, in case there's a disagreement between two people, to the extent you are using some of these survey tools or more intentional voting sort of mechanisms, then it's nice to have an odd number.

And then once you get bigger than seven, it's very easy to have a dilution of accountability, right? So, if you have a committee of 13 people all based in the US, all fixed income experts, you know, making a call on duration, then who is accountable if that's the wrong call? So, I think keeping it small tends to work well, also, just practically in terms of airtime, right?

So, if you have 13 people and you have a 45-minute meeting where we do the math pretty quickly, we're gonna have two to three minutes to share views. It just doesn't seem like the best use of those individual's times. And again, you probably have somebody that's pretty close in view such that you can make that number smaller and not really lose too much information.

GREG HALL: Interesting stuff Devin. How would you move this over into the advisor conversation? Where do you see some of these things materializing?

DEVIN EKBERG: Yeah. Well, I'm really glad to hear Anastasia talk about things like systems and processes and things like that. The advisor world has started to move into that direction where, you know, it's more about establishing those systems almost as form of a default decision making.

My brothers in law enforcement, he's taught the same thing. He's taught to somewhat manage his emotions in favor of kind of a default, you know, a standing operating procedure or rules of engagement. Because the theory is that the default decision making will be better when you've made those decisions in advance.

And so, I think advisors have done a really good job, especially with clients who, you know, might have a very emotional response to what's going on in the markets, right? They're reading the headlines, they're reading the news, they're worried about wars and inflation and tariffs and a thousand other things that are being fed to them. And so, advisors are sort of acting almost a little bit as therapists and saying, let's manage those emotions. Let's maybe try to change what we think those things mean to us.

So, they'll try to change what that means to them. Maybe instead of fear in around their portfolio, maybe the advisor will help that client feel some form of excitement maybe, or are there asset classes that maybe look more attractive than they were, you know, a few months ago or a few years ago? Are there things that we can do in our portfolio, small changes instead of big drastic changes that are a little bit more constructive?

GREG HALL: You brought up two things here, but, because I do, I really want to talk about how advisors handle client emotion. we joke and advisors joke with us that, you know, they sort of serve as the financial, like the financial therapist to their clients, the financial doctor, as you know, as a term that gets thrown around.

But you brought up two things that I just, I wanna dwell on for one second. One was, you know, the team dynamic that, I mean, one of the major changes in the advisor community over the last 10, 15, 20 years has been that the increasing prevalence of teams. So, it's rarely is a financial advisor operating is a one-person shop.

So, it sounds like from both of your perspectives, that introduces all manner of opportunity to make better decisions, but also a need to maybe think about the construct under which you're making those decisions and be really mindful of that. And I don't know Anastasia, if they've got seven folks on a team sort of capable of making an investment decision.

But I'm curious, you know, do you see maybe a different dynamic in smaller groups? Are there advice you'd give to folks who are, you know, maybe in a smaller team of principals still trying to make really good high-quality decisions?

ANASTASIA BUYALSKAYA: Well, I think just recognizing that there's always a trade-off between decision speed and decision quality. And so, the more people that you bring into the conversation, you're gonna slow down the decision-making process. And we do that because we think it's gonna result in a higher quality decision. And oftentimes it does, but sometimes you don't have that time, right? Markets can move very quickly.

Clients can get very impatient sometimes. So, I think just recognizing that that trade-off is there and adjusting if you find yourself over indexing on one or the other. So, if you find that, you know, there's a lot of people in the room, but honestly, I feel like with the input of three of them, we are already at that decision, or we get there pretty quickly, then maybe you've over-indexed on having too many people in the room, or if you find yourself having a lot of open questions, but the decision needs to be made, then maybe bringing in more people into the room would be helpful.

But I actually also wanna respond to one thing Devon said, which it sounds like very much best practice, which is having the clients think about what they would do in what we call kind of a cool head state.

So, before they're experiencing a big drawdown, before they're in a position where those emotions are likely running high, sort of doing that pre-mortem on their own portfolio and saying, you know, if we go through a 20% drawdown, what would I do and how would I change that allocation?

And you brought up your brother, I mean, this is really something that we see in a lot of high stress professions, right? So, medicine definitely, law enforcement, military, these are professions that are big fans of checklists and pre-mortems, because those professions are very well aware that it's difficult to have a hundred percent of your cognitive energy focused on making decisions when there's so much going on in that sort of emergency state.

DEVIN EKBERG: It's also a smart practice because, you know, every time you engage the cognitive part of your brain, you deplete the resource. It's very difficult to maintain that cognitive energy all day long. There's all sorts of studies about the timing of making decisions. And you've probably seen some of the studies on even judges in the courtroom will make certain decisions in the morning and very different decisions in the afternoon because their caseload is so high and they're just completely drained.

Everybody that's been on a diet before knows that same thing. You're super disciplined throughout the day. You know, you're breakfast, lunch, and dinner, and then you go wreck a bag of Oreos in your hotel room at midnight because your discipline level is way low. And so, it's having those processes pre-established, the pre-mortem exercises, the red teaming, which is sort of a sense of trying to challenge your assumptions when you're at your best.

And then you have to have a high bar to go in and make, once you've made those decisions, you need to have a very high bar to go in and change those decisions. Think so that you're not just reacting emotionally.

GREG HALL: One of the things also to pull on that thread a little bit, and I imagine this is helpful too, you know, my financial advisors, when we form that policy statement, if you will, or that sort of macro action plan, they've recruited me into the decision-making process. And it's that much easier when immediately, you know, three weeks later, I changed my mind based on a headline.

They say, Greg, remember we talked about this and here's the plan that we laid out. And that's obviously incredibly helpful to remind me that I, in a cooler state, had come up with, had come up with this or had signed off on it. So, I think it's a great way for financial advisors to make sure that their clients feel a sense of accountability and ownership for their own plan.

ANASTASIA BUYALSKAYA: I completely agree, and it's exactly the strategy that I use with investors where, you know, I'll go to them and they'll say, well, you're telling you to make this decision. I say, no, your former self is telling you to make this decision because you committed to this, you know, three weeks ago. And I completely agree. I think it's a much more effective strategy than trying to interfere without having kind of a stake in the outcome of that decision.

GREG HALL: So, one of the things that Devon said a little while ago that stuck out in my head is you were talking about financial advisors, clients, and the concerns they develop because they're being fed information. “Fed” was the term that you used. And I think that is an incredibly important topic to talk about. We hear about it these days often in political terms.

But I would imagine that, you know, your news sources or the sell-side research you choose, or the strategists you tend to listen to if you're an advisor sitting on a big platform, you've got your in-house strategists, you've got external sources that you may care about, there may be an author at a particular publication that you like to listen to, but I think it must really influence behavior, or the sources of information must have a profound influence on behavior, even in areas like finance, where you would expect some of, at least, the bulk of the information to be rather objective. And I'm curious how you see this manifest itself. Either of you.

DEVIN EKBERG: Well, since I brought it up, I can maybe clarify what I maybe thought I meant when I said being fed information, you know, like, so our information systems around us are curated for us more than I think we appreciate. And so, one of the best practices that advisors, I think, can look into is being very aware of the source of information that they're consuming and how they're processing that information.

And potentially understanding why and how that information is being fed to them in a way, potentially on purpose, to sometimes influence their decision making. So, everything you read on social media or through the news and things like that is pretty heavily curated.

I have these conversations with my daughter all the time. She's 16 years old, she's consumed with social media, and I tell her that, you know, there's a billion dollars’ worth of engineers on the other side of that app trying to keep you scrolling on that app and showing you information in very specific ways to influence your behavior.

And that's very true. And often we do talk about that in a political sense, but even in the financial world and pretty much any other world that we operate into, you know, being aware of how that information is being fed to you can actually influence your decision making there. I'd love to hear Anastasia's take on this, because this has to do with some of the gamification and other things like that that you've been studying and some of your work and how these systems are developed for information.

ANASTASIA BUYALSKAYA: Yeah, I mean, when I think about information consumption, I feel like it's gone through a number of revolutions. You know, I still remember when you'd go to a newsstand and you would make an active choice between two newspapers, and you knew that you were choosing a source which may be confirmed some prior views, like you saw, maybe not a full sample, but you saw a representative sample maybe of sources out there.

Then we became more abstract with sort of digitally intermediated news where, to your point, Devin, everything we see is in this echo chamber of social media. We see the stuff that's similar to the stuff we've seen in the past, right? And so, we're less likely to be aware of the fact that it maybe is not representative of all the primary sources out there. And now we're even one step away from that, where now we're turning more and more to AI, which doesn't even tell us what the source is, right?

Or maybe it's like somewhere in the Cliff Notes, but nobody's really going to those Cliff Notes anymore. And so, we have this kind of like the truth, but that's all based on sources. And those sources, to your point, are pulled from things that are similar to things we've liked in the past. And so, I think we're getting more and more removed from those primary sources.

And it's a big question for how does that influence decision making? Does that fuel overconfidence in our own views? Does it fuel confirmation bias? Or can we actually use some of these tools to improve decisions? I think it's an open question.

GREG HALL: I mean, I think, you know, and it's not just social media, which I mean, I think, you know, pretty well documented some of the tricks and tools those platforms use to maintain attention, and then they monetize attention. And I also have a 16-year-old daughter and a 14-year-old daughter. And that's a topic of frequent discussion in the Hall household.

But also, you know, every advisor exists within some form of ecosystem now, you know, truly independent advisors, you know, due to some of the consolidation that's going on in the RIA space, right? Lots of advisors listening are affiliated in some way, shape, or form with a larger platform. And that larger platform will have its own imperatives. It's trying to push through the advisor ecosystem.

And that's, you know, every advisor I know is a bit of a, you know, a loyal company person, and many of whom really happy to be on these platforms, but always a bit of an entrepreneur, definitely an independent thinker and trying to balance that internal voice and the external voices that they listen to.

And then you also have a phenomenon of, you know, it may not be the platform that you work for, but there's an external technology provider that wants to tell you about risks in your portfolio, wants to advise you on at-risk clients, that wants to maybe feed you news associated with what's in the portfolio. And so, you know, this problem has many layers.

And Anastasia, I think you've done work on just how much people are influenced by what is point and click, what is easier in the context of the environment that they're in. Because I guess this is a bit of nudge thinking, right? But maybe you could expound on that a little bit. because I just, I want advisors to sort of, if they don't know already, to understand how unthinkingly sometimes their decisions can be dictated by the button that's in front of them, rather than they might bring into kind of a 360 evaluation.

ANASTASIA BUYALSKAYA: Yeah, And to Devin's earlier point, I've been doing more research on this phenomenon of gamification. There's been gamification of everything, including our financial decisions. And increasingly, you know, digital broker-dealer apps will employ gamification.

And having learned sort of what's happening in the brain and how sensitive we are to any sort of dopamine, you understand very quickly why those things work because they create the system of rewards, which maybe are completely vapid rewards, but they do release dopamine in the brain, and then the brain responds to that.

So, I think they've hijacked that kind of dopamine system really, really well. And we've seen it used for good. So, if you think about sort of your Fitbit, right? A lot of these apps that kind of gamify your health and your wellbeing, they also tap into the same systems, right?

GREG HALL: I check my ring every morning to know how I'm feeling, you know? I used to just wake up and know how I was feeling, but now I have to check an app to find out.

ANASTASIA BUYALSKAYA: Exactly. That's right. And how well you slept and, you know, how much energy you'll have that day. Yeah, absolutely. So, I think there's a lot of gamifications for good, and to some extent, I think it's been used for good in the sense that we've seen, and you'll know this better than me, but I think we've seen segments of certainly the retail market engage with these apps and actually put money into the markets that we haven't in the past.

So, I do think that gamification has led to some democratization, if you will. But I think understanding when that could lead to overtrading, when that could lead to sort of excessive risk taking that you later regret, that's really important. And so, I've been much more interested in doing research there.

GREG HALL: I'm always leery of that term democratization or in financial services. It's used freely and sometimes it's employed by, you know, firms that, you know, they claim like Prometheus bringing fire from on high. They claim to be, you know, out the goodness of their hearts, you know, bringing these tools or these investment approaches to the huddled masses.

And I, again, you know, maybe my own priors, but something I think financial advisors ought to be on the lookout for is just, you know, when something is described as a gift that's being brought through democratization, oftentimes the bringer of that gift has quite a lot to gain by virtue of involving you or your clients in something. Not to be cynical, sorry, to put a downer on the conversation.

ANASTASIA BUYALSKAYA: No. I think that's exactly right. And if anything, it highlights the importance of that role because going back to something Devin was saying, you know, these apps are very good at hijacking that very automatic sort of reflexive part of the brain.

And a good financial advisor, like everybody listening to this podcast, will very much engage with that reflective part of the brain, will do all these best practices around, you know, checklists, pre-mortems and make sure that the client is making decisions in a way that they're unlikely to regret later on. Which is not always the case with some of these apps.

DEVIN EKBERG: For me, and especially for financial advisors, I actually think this is an opportunity to get very optimistic. In fact, this is actually the value of professional advice, right? It's to help manage, you know, everything that you are fearful about or you see problems with that are totally outta your control. And in many cases, they're really just abstract pieces of information that you don't really know what to do with. There's no action to be taken with that information.

An advisor can take all of that abstractness and connect it back to the stuff that people actually care about. And that's the context. It's not just about investment management, it's not just about portfolios. It's not just about asset allocation just for the sake of asset allocation and performance, just in like an abstract sense.

It's connecting all of that performance to the stuff that the client cares about, which is, hey, do you need liquidity for a purchase in the next year or two? Or are you sending your children to college in the next few years? Are you wanting to retire with a certain lifestyle at a certain time? Are you looking to leave a legacy behind? And how does this portfolio and the decisions that you're looking to make today impact those goals long term?

So, they can really act as a grounding mechanism to all of that stuff that's circling around those clients. And I think that's really where that value of professional advice comes. So, I'd be very optimistic if I was a financial advisor in the face of all of that stuff that's been so disruptive.

GREG HALL: There's been a lot of talk. You know, Devin, just playing on that theme a little bit, the value of advice. And like you, I'm a big believer in the role of the human being, you know, for at least for the foreseeable future in my mind, in helping other human beings grapple with the problem of being human in a world where you need to make good decisions.

But AI looms on the horizon, or is already here. And there's been, you know, there's been news flow. We've even seen, you know, there was a story about one of the AI companies coming up with a tax planning, you know, module and a bunch of wealth management stocks got hit, you know, on that day.

And so, there's a vein of discussion about AI replacing the financial advisor. I don't want to dwell on that too much. But I do wonder to what extent you guys think, and I'll start with Anastasia, like, do you think AI is good or bad for decision making? You started to talk a little bit about the footnotes. But just on balance, you know, is this gonna help us make better decisions or is this going to prey on all of our weaknesses, our susceptibility to flattery and confirmation bias and end up, you know, being making a worse off?

ANASTASIA BUYALSKAYA: Yeah, I think you could find behavioral scientists on both sides of that debate. There's certainly a lot of research on how the tools, you know, they are typically sycophantic. So, the algorithms are built for engagement. They want you to go back and use those tools a lot. So, if they were saying, no, Greg, that's really a terrible question.

You probably are not gonna use that LLM quite as often. And so, they say, Greg, that is such a great question. That's exactly the question you should be asking about your financial plan. So, they do flatter you, and they do have a tendency to find, you know, data and evidence to support what you wanna hear. Going back to this idea of confirmation bias. At the same time, like any tool, you have the power to use it in a variety of ways.

So, if you know that it's prone to be sycophantic, then you can make your prompts such that, you know, you say, I need you to play Devin’s advocate and tell me why this financial plan is likely to fail, or, you know, run a big Devin’s advocate on this investment thesis. So, there's a big area of prompt engineering, and I think it takes a little bit of experimentation because some of these tools are very sensitive to exact nature of the prompt.

But I've seen investors use these tools for good, use them to question their own decision making, use it to, you know, run various counterfactuals that otherwise would be very time-consuming for human analysts, let's say to run. So, I think the potential is definitely there. I will just plug, there's a really nice piece from Lisa Messeri and Molly Crockett who are both neuroscientists looking at, I think the piece is called AI and Illusions of Knowledge.

It's a very nice title. And they do warn about, you know, some of the new biases that we're at risk of when we use AI. So, things like the illusion of explanatory depth, which I love, which is the idea that you will ask AI, you know, a question and the response will feel very sort of self-contained and very well written. And you will have a sense that after reading that one page response, you really understand the answer to that question really well.

And their point is, you actually probably understand the tip of the iceberg and you might be a little bit overconfident. 'Cause there's a whole bunch of stuff that you don't understand. And I think the best way to test this is to use these tools in your own domain. So, I'll use AI a lot and ask it questions about behavioral finance and we'll sort of makeup papers or it'll make up biases.

And I'm much better placed to know that than if I were to use AI in a different domain. So, kind of to answer your question without really answering it, I think like any technology, we need to learn how to use it so that it's working for us rather than amplifying all of these biases.

GREG HALL: It's funny, I mean, I can picture you writing a paper on the biases and priors of AI in the same way that you explore what might happen in an investment committee meeting. I mean, the large language models I've noticed, you know, they will return an answer based on the volume of writing about a given topic. And so, if a viewpoint just has more writing about it, then it becomes the answer.

And then what you were just describing, it is so funny. It reminds me, I used to work with somebody, a brilliant person who was the most articulate arguer. You could not win an argument with this person, but frequently wrong, but so they would turn your mind around and win the argument every time, but it didn't mean they were right. Right. It looked good, it sounded good, but it didn't end up being the right answer very quiet frequently. So, it's interesting how human these failings of AI seemed to me when you recount them.

Devin, I'm, you know, I'm curious again, on this, on the knowledge gathering, on the information gathering front, you know, do you see more advisors resorting to AI in meeting prep? You know, t's such a fabulously efficient tool for, I did it before we started talking today.

And have found it to be, you know, a fantastic way to get ready for these conversations. Is that something that you're seeing more of? Is that something that you're seeing maybe cause some additional kind of cognitive biases as advisors recount their kind of daily lives to you?

DEVIN EKBERG: And we've seen it even before AI. Advisors have always been looking at ways to get more efficient. And you know, we had some of the similar conversations during the robo-advisor years. A lot of people were scared that the robo-advisors were gonna take over the real thing. I think absolutely those productivity tools are making a huge difference and advisors are finding ways to do that.

You know, I think back there was a famous study by Vanguard called Advisor Alpha, where they tried to quantify the value of a financial advisor, right. And they landed, they quantified it literally, they landed at around 300 basis points a year. And there was different categories where they said that financial advisors add value. And there was about six or seven categories there and they were things like portfolio allocation, withdrawal strategies, tax strategies, and there was six or seven of these things, and one of them was behavioral coaching.

And all of those put together, you know, produced about 300 basis points of value every year. Now, it occurred to me, when you look at that, those lists of categories, like six out of the seven things that they identified that advisors took credit for, you know, providing value AI is already doing and probably doing better than a human advisor's doing, right? Like withdrawal strategies, tax strategies, portfolio allocation models, things like that. AI is doing a pretty good job and will probably end up getting even better.

The one on that list that stood out to me was the behavioral coaching. I just, I don't see that AI is gonna replace that human-to-human model. You know, currently the AI models will spit out, you know, a 35-page response in what a client should do when the advisor might recognize, it's like, Hey, this client's having an emotional response before we make a decision about their portfolio. Maybe we should actually just take a walk around the block first. Right. Maybe just to settle down the nervous system a little bit. Maybe you can…

GREG HALL: I take your point. I take your point completely. And I remember looking during the robo era, you know, looking at, we were being told by consultants that game over, robos are taken over, obviously, I think maybe to some degree a self-interested conclusion that they'd arrived at.

But a few years later, what it showed is, you know, I don't know if it was an exhaustive study, it probably wouldn't meet Anastasia's criteria academically, but it showed that as clients hit certain wealth thresholds as things really began to matter to them, immediately turned to a human being to help them do exactly what you're describing, Devin, which is ground the logical and the emotional and kind of bridge that gap.

I want to ask Anastasia, just maybe coming back to markets a little bit, one thing I'm curious about is, do you think that this awareness of behavioral science and its implications for finance, you know, we talk a lot, it's been so long since we've had a steep downturn in this economy.

And we talk a lot about the monetary advances and the technological and productivity advances that have maybe helped to keep us out of recession territory. Do you think that this more of a shared awareness of our own behavioral biases has contributed to us maybe not seeing the kind of crisis of 2008, you know, happen again?

ANASTASIA BUYALSKAYA: I think that's a very generous hypothesis. I would love for that to be the case that everyone's just much more self-aware and so we're seeing fewer of these bubbles and hopefully won't see another global financial crisis at least of that size. But I do think memory can be short and obviously the composition of people in markets changes every decade.

And there's really nice work from Ulrike Malmendier looking at experience effects. So, she looks at, you know, essentially, we can all read books about the Great Depression, but if you haven't lived through it, it's not gonna have as much weight on your decision making. And she has great research basically looking at how the things that individuals lived through have really lasting influence on their financial decision making and how they think about risk and portfolio allocation.

So, it's possible that as those of us that remember some of these big downturns kind of leave the market, and retire, and more and more of those actors are leaving the market that we do get another crash. And that's, you know, that's probably more likely than not seeing that crash again. But I think you're right in the sense that much more market participants are aware of behavioral finance and are aware of at least some biases that they might have that other market participants have today than I probably saw 20 years ago.

GREG HALL: Well, it's a really interesting point you make about the sort of the visceral experience versus the academic, you know, just the, you can appreciate something intellectually, but not having been through. We see this often. I mean, Devin, you know, there's a palpable difference. Advisors we meet who lived through, be it, you know, the Asia crisis, the Russia crisis, Long-Term Capital, the dot-com boom and bust, the telecom bust, Enron, financial crisis.

And, you know, and then here we are in today, and lots of people, you know, extrapolating, you know, great times to come, almost sort of, you know, without a thought to what, what could potentially go wrong. But you know what, we always go down this path.

We're fixed income people and we tend to be pessimistic. Let's not do that today. This has been too fascinating a conversation to end on a dull note. Anastasia, we could go on talking to you all day. This is so fascinating. Please, please promise us you'll come back and do this again. Maybe next year we can touch base with you on more recent advances in your field of study. But thank you, thank you so much for your time.

ANASTASIA BUYALSKAYA: Thank you very much. It's been a great conversation. And with great pleasure to come back next year.

GREG HALL: And Devin, thanks for your time too.

For those of you listening, I hope you enjoyed today's conversation as much as I did. If you want to go deeper on any of these topics, first of all, we will link to some of the papers that Anastasia referenced as well as her own work in the show notes.

So that's a good place to start. If you'd like to go a little deeper even than that, you can come to pimco.com in the United States. If you identify yourself as a financial advisor, you'll be taken to Advisor Forum. That is our destination for you to get what you want from PIMCO as quickly and efficiently as possible so that you can move on with your day and have terrific conversations with your clients.

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