Education

What is the Behavior Gap?

Behavior Gap Drawing

The Behavior Gap is a term that describes the negative impact of poor decisions made by investors.

Let’s face it. Investing your hard earned dollars is emotional. This sometimes makes us act irrationally. This doesn’t mean we aren’t smart but financial decision making is heavily impacted by human psychology. We are wired to avoid pain and seek pleasure.

Impact on Returns

Over the past 20 years through 2014, the behavior gap has been just under 5%. This means that the average equity investor underperforms the average equity mutual fund by 5%.

Types of Mistakes

  • You may want to increase risk when stocks are high because everyone is bragging about making money.
  • You may want to sell when stocks are low and everyone else is freaking out.
  • You are in cash and get a case of “FOMO” (Fear Of Missing Out) when the markets are ripping higher.

“Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well.”

– Warren Buffett

How much can an advisor help?

Vanguard recently did a study and proposed that financial advisors can add about a 3% increase in returns over the long-term. Portfolio construction and wealth management (rebalancing and financial planning) make up about 1.5%. Behavioral coaching adds about 1.5%.

How TIM can help

  • Create a comprehensive financial plan – this will help you focus on the longer-term. By checking the plan during times of stress, you should begin to realize that shorter term fluctuations will not have a material impact on your long-term goals.
  • Behavioral Coaching – Advisors are here to walk you back from the ledge in times of uncertainty.
  • Communication – By communicating our thoughts on the markets weekly, you will be prepared mentally when big up moves or down moves happen in the market.

If you have more questions about behavioral finance, feel free to give one of our advisors a call. We would be happy to help you prepare a comprehensive financial plan that should help to mitigate the behavior gap.

“Be fearful when others are greedy and greedy when others are fearful.”

– Warren Buffett

Total Investment Management, Inc. offers this commentary strictly to educate, inform and share our thoughts on the markets. Nothing here should be construed as investment advice. Past performance is no guarantee of future results.

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