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NewsMaterial3 min readDisconfirmAI Editorial

Orion Chief Behavioral Officer Daniel Crosby: Winning Funds, Losing Investors

Behavioral psychologist Daniel Crosby uses the example of a fund that returned 18.5% annually but caused average investors to lose money to explain the difference between mathematically optimal and behaviorally optimal portfolios. He proposes a three-dimensional framework of risk capacity, risk tolerance, and risk composure to illustrate why knowing what to do does not guarantee doing it during a market downturn.

2026-10-27 22:12 GMT+8

A focused equity fund delivered an annualized return of 18.5% between 2000 and 2010. During the same period, the S&P 500 Index declined slightly; this decade is known on Wall Street as the 'lost decade,' making the 18.5% performance exceptional by any standard. However, if you examine the actual returns of the average investor in that fund, the answer is a loss. The fund made money while its investors lost it; the discrepancy stems from the timing of buy and sell decisions.

Daniel Crosby, Chief Behavioral Officer at Orion Advisor Solutions and a psychologist, discussed this case while promoting the new paperback edition of his book The Behavioral Investor on the Excess Returns podcast. He used the example to introduce his core argument: there is a fundamental distinction between a 'mathematically optimal' portfolio and a 'behaviorally optimal' one. A mathematically optimal portfolio offers the highest theoretical return within a mean-variance framework; a behaviorally optimal portfolio is one that investors can actually stick with despite real-world emotional volatility. If an investor cannot resist selling during a sharp decline, even the highest theoretical return is irrelevant to them.

Crosby argues that traditional risk assessment measures only two dimensions, missing a third. The first is risk capacity: how much risk you can afford to take based on your goals, timeline, and existing wealth. The second is risk tolerance: the trade-off you are willing to make between risk and reward when in a calm emotional state. Crosby notes that research indicates risk tolerance remains relatively stable throughout a person's life and does not fluctuate significantly.

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The third dimension he proposes is risk composure: the likelihood that strong emotions such as fear or greed will alter your perception of preferences established in a calm state. In other words, instead of asking 'how much risk are you willing to bear?', the question becomes 'what is the probability that you will overturn yesterday’s answer when the market crashes?' Crosby links this dimension to the personality trait of 'neuroticism'—individual differences in anxiety proneness—and observes that this variation is substantial across the population.

In practice, this means portfolio construction must address not only 'what should be held' but also 'under what emotional conditions one might abandon holding.' Crosby suggests providing additional behavioral coaching and early warning support for investors with lower composure rather than simply reducing their risk exposure, as lowering risk might prevent them from achieving their financial goals. He simultaneously warns that over-intervening with investors who have high composure can be counterproductive. He cites A/B testing results from Betterment, a robo-advisor, which showed that sending 'don't panic' alerts during volatile periods actually triggered trading among clients who had previously shown no anxiety, effectively planting seeds of worry where none existed.

The value of this framework lies in transforming 'behavioral bias' from a vague label into separable variables. Risk capacity can be calculated through financial planning, risk tolerance can be measured via preference surveys taken in a calm state, and risk composure requires additional identification mechanisms. Crosby believes the industry has long addressed only the first two, leaving the third as the key gap explaining 'why investors lose money in good funds.'

It should be noted that this is an attribution framework proposed by Crosby as a practitioner, not an investment strategy validated by independent experimentation. The fund case he cites comes from a single source, and the analogy between composure and neuroticism derives from personality psychology literature. He provides no controlled data demonstrating whether incorporating composure into risk assessment actually improves investor behavior. The framework’s diagnostic power (explaining why good funds result in losses) is stronger than the validation of its prescription (how to specifically measure and adjust portfolios accordingly).

Sources

  • podcasters.spotify.com↗
  • morningstar.comMorningstar, Inc.↗
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