May 2020 | Posted By PJ McDaniel

We talk a lot about the importance of education because we believe that educated investors are disciplined. In our experience, discipline builds confidence —and confident investors have a better experience. But we also know that we can go months, even years, without a real test of confidence. A test like we are facing now.

The coronavirus pandemic has shaken nearly every aspect of life and sent the markets into wild swings of despair and euphoria depending on the day’s headlines. With this much uncertainty and this level of market volatility, investors must be especially vigilant against falling into the Behavior Gap.

The Behavior Gap is the name coined by author and podcast guest, Carl Richards, to describe the fact that most investors earn less than the market’s returns, simply because they make poor decisions. Chasing hot stocks when the markets are booming or panicking and moving your money into cash—this is the kind of behavior that creates the gap. And it’s a real, quantifiable number.

For 25 years, the research firm DALBAR has been publishing its analysis of the difference between the average investment return, and the average investor return—and it looks bad for the average investor (though some journalists discount the findings and methodology).

For example, stocks have delivered an average annual return of roughly 9% over the last 30 years, while bonds have delivered an average annual return of 6%. If we imagine a 50/50 balanced stock and bond portfolio, that means the investment markets have delivered a 7.5% average annual return over the past 30 years. The average investor, though? They’ve only achieved a 4% average annual return. That difference of 3.5 percentage points per year for the last 30 years adds up to a huge number.

Say you had $1 million in your retirement account. A 4% annual return for 30 years would result in a balance of about $3 million. But if you’d gotten the market’s combined 7.5% investment return, you’d have almost $9 million after 30 years. The Behavior Gap in your savings, then, is missing out on $6 million—all because you let emotions into your investment decisions.

Right now, the risk of succumbing to emotion is especially high. A friend of mine, who is  a successful businessman, recently sent me a note saying he was day-trading while sitting at home in quarantine. He’s buying stock in Zoom and pharmaceutical companies, thinking he can predict what’s going to happen and pick up a few wins. He’s a smart guy who really understands commercial real estate, yet here he is making classic investment mistakes. He’s in the Behavior Gap.

I urged him stop gambling with his money and consider allocating it into 13,000 stocks spread all over the world, like we do. Then I encouraged him to get off the couch and find some other way to pass his time. Because the pernicious thing about the Behavior Gap is that it doesn’t just cost us money. It can have the same draining effect on our happiness as it does on our investment accounts.

As Carl Richards told Matt in his recent podcast interview, he now applies the Behavior Gap concept to any activity that we engage in hoping to improve our situation, but which in fact produces a suboptimal result. Just as making ill-timed, emotional investment decisions hurts our long-term returns, spending emotional energy on things that aren’t useful produces a lot of unnecessary pain, suffering and anxiety.

That’s why we also emphasize to clients the importance of focusing on the things that bring real meaning to their lives. In fact, a framed print of one of Carl Richards’ famous sketches hangs on the wall of Matt’s office, reminding us that our job is to help people stay focused on the small overlap between things that matter and things they can control.

So even as we face ongoing uncertainty about what the post-coronavirus world will look like, remember to focus on what matters, and what you can control. That includes having faith in the evidence that this market downturn, like others, will end. Stocks will recover and disciplined investors will be rewarded. In the meantime, we will be taking care of what we can control, like rebalancing your portfolio and harvesting losses.

Keeping the faith, staying disciplined—that’s exactly what makes our clients different from the “average” investor. And it’s how we help you avoid falling into the Behavior Gap.