The Behavior Gap & Avoiding It

The behavior gap refers to an investor’s behavior causing them to deviate from a long term planned investment strategy – and earn far less than what they could have. Click to enlarge, back button to return. Each year Dalbar updates this chart showing what the average equity fund investor earned in returns over 20 years ending in the year shown, (in red), compared to what the SP500 earned (in green). I can’t overemphasize the importance of understanding and avoiding this huge Gap! Imagine that psychology and behavior are more important than investing technical matters! Click to enlarge, back button to return. As an example look at 2012. In the 20 years ending 2012, the SP500 annualized return was about 8% while the average equity fund investor realized only 4%. Let’s look at how our emotions impact us as the market goes through highs and lows. Click to enlarge, back button to return. Starting at the left side of the chart, consider someone that bought an investment because they heard it has been doing well. Unfortunately not long after they buy it, it hits a peak and starts dropping, and the emotions are overwhelming as they watch it drop – there’s a good chance that they will abandon it for something else and end up with zero gain or even a loss. They won’t invest again until the market has already past its low point and gone up for quite a while. They miss the entire first half or more of the rise! You can see why it is called “chasing performance” and it is the curse of most of...

Solving the biggest 401(k) Problem

What’s the biggest problem with 401(k) plans that is not being addressed? It’s the investment returns of the participants. How do you maximize the number of participants holding a highly diversified global portfolio? Yet the basis of 401(k) plans is that participants have the freedom to put their money where they wish! How can you ensure great investment decisions in that environment of freedom? We have a way – but first let’s see what plans look like now. As you can see, typical plans have way too many choices – too many groups of choices – and no investment advice. Participants receive “fund education” only – no investment help!  (Click to enlarge, back arrow to return.) As you look at this depiction of a typical plan fund line-up note these problems. Remember the goal should be DIVERSIFICATION. Overlap is the opposite of diversification. Note that some active funds overlap with themselves, the active funds overlap with the index funds, and both active/index overlap with target date funds. All the funds expect index funds are under-diversified. Often Plan Sponsors yield to the idea of “pleasing” participants with the fund options by offering more. That is a breach of their fiduciary duty since this hurts participants’ returns. Give them what they need to maximize their success not what they want. Addressing the target date fund, proprietary and opaque fund problems requires a separate blog post. Bottom line – today’s 401(k) fund lineups do not result in participants holding highly diversified global portfolios, which should be the goal. Here’s a telling story. We help our family clients decide how to allocate their money in their 401(k) accounts. We...