Investor Behavior Gap

We have a hard time believing that our own actions could be the cause of our investment returns being less than they should be.  I was investing my own 401 (k) assets while working at Chase Manhattan Bank in early 1991.  The news of the day was the imminent attack by the U.S. on Iraq to free the country of Kuwait known as Operation Desert Storm.  This was before I became a financial advisor and thus I followed the “advice” from the pundits who stated that the stock market would sharply decline when this military action occurred.

Even during military operations, the US stock market  advanced.  Investment behavior will be key to capture returns.Even though my investment time frame at the time was over 50 years , I switched my 401 (k)  asset allocation heavily to bonds (out-of-stocks).  The U.S. did attack Iraq and the pundits were wrong.  The stock market did respond strongly, but in a positive action.

My actions caused me to miss out of the stock market gains.  This ever happen to you?  I learned from that lesson and now try to help others to avoid making these same mistakes.

Every year the research firm Dalbar does a study that tries to quantify the impact of investor behavior on real-life returns by comparing investors’ earnings to the average investment (using the S&P 500 as a proxy).  As a reminder, the S&P 500 index captures the largest publicly traded companies in the U.S.

The latest study looks at the 10-year period that ended Dec. 31, 2012:

  • Average investment return = 8.21 percent
  • Average equity investor return = 4.25 percent

If you had put money into an S&P 500 index fund 10 years ago and just left it there — no buying, no selling, just investing and forgetting about it — you would have earned (minus fees) a little bit above  8 percent.  Remember, this time period included the “Great Recession” and the 2008 loss of over 38% in the S&P 500 index.

So why did the average equity (stock) investor only earn 4.25% during this same time period?  Because of their actions or their own behavior.  They either sold their stocks in 2008 at a low or purchased at a high and sold at a low probably several times during this time period.  They listened to the pundits and reacted to the news of the day throughout this 10 year cycle.  We have a saying called “Behavior Gap” that address this action.  The difference in return investors experience versus the investments that they own.

Below is a sketch created by Carl Richards who has become a frequent keynote speaker at financial planning conferences and visual learning events around the world.    Through his simple sketches, Carl makes complex financial concepts easy to understand.What is really interesting is how little this seems to change over the years. When it comes to investing, the tendency to behave badly is not going away.

Behavior Gap

So what do we do about it?   You should realize the tendency to emotionally react to current events, and work with someone to help you have the discipline and patience needed to stay with your plan.

For most of us, money is bound up with powerful emotions such as security, confidence and  sometimes fear.  But the emotions of investing can cause you to lose focus on important areas of your financial life, most of which have absolutely nothing to do with the stock market.

 

The way our brains are hard-wired can cause us to make emotional decisions about our money at precisely the wrong moments.

The reality is investing successfully is hard. But hopefully by focusing on our behavior, we can close this gap in the next 10 years. Work with a competent advisor to help you stayed focused on your long term objectives.

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About Dan Crimmins

Dan Crimmins, co-founder of Crimmins Wealth Management, is a financial coach and fee only financial planner. Have a financial question? ASK DAN

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