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.

dalbar

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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!

dalbar-2012

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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.

chasing-perf

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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 the human race.

dalbar

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Returning to the Dalbar chart – I think that now that you can understand how this can happen as investors buy when they should do nothing and sell when they should do nothing. The activities we should focus on is saving and occasionally re-balancing- not react to recent market moves – or react to a lack of recent market moves.

Let’s look at the impact of earning half of the return each year for 20 years. It’s all about compounding. I wish our schools devoted much more time to the math topic of compounding!

four-vs-eight

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If you earn 4% annualized over 20 years, because you are subject to the Behavior Gap, $1 grows to $2.19 – an increase of 119%. However. If you earn 8% annualized with our guidance $1 grows to $4.66. That’s a 366% increase – so 8% over 20 years gives you almost 3 times as large a gain as 4%! Imagine having so much more in retirement! We get so caught up in trying to hit a homerun – when the homerun is right there in front of us. Choose a sound investing strategy or even better an advisor who recognizes and understands the numbers and the psychology, and stick with it. Save early and often! Be patient!

We will make sure that you do not experience the behavior gap in your investing.

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