How Could the Behavior Gap Affect Your Investments During This Time of Market Volatility?
“It turns out my job was not to find great investments, but to help create great investors,” writes Carl Richards, author of “The Behavior Gap.”1 From increasing our budget mindfulness to taking a steadier approach to investing, Richards has drawn attention to the way our unexamined behaviors and emotions can act to our detriment when it comes to living a happy and financially sound life.
When experiencing panic or anxiety, it's easy to make bad financial decisions. In the past few weeks, the Covid-19 pandemic has affected nearly every industry and home as people and governments take action to keep themselves and their community safe. The stock market volatility of 2020 has been an effect of people reacting to the news, with wild swings down and up as the situation evolves. But reaction-based behavior can harm you in the long run.
The Behavior Gap Explained
The "behavior gap” refers to the difference between a smart financial decision versus what we actually decide to do. Many people miss out on higher returns because of emotionally driven decisions, creating a gap — “the behavior gap” — between their lower returns and what they could have earned.
4 Common Emotions that Can Create a Behavior Gap
#1: Excitement When Stocks Are High
Whether in a bull market or witnessing the hype from a product release, many investors may feel tempted to increase their risks or attempt to gain from emerging investments when stocks are high. This can lead to investors constantly readjusting their portfolios as the market itself experiences upswings. An investor who follows such patterns is likely to do the same with declines and may end up trying to time the market.
#2: Fear When Stocks Are Low
As a response to the recent coronavirus, the market has seen losses as many investors feel drawn towards less risky investments.2 When stocks are low, a common response may be to sell. But this locks in losses, as well as effectively missing out on potential long-term gains. Getting out of the market may seem like a safe move, but what if the market suddenly rises (as has happened multiple times in the past few weeks)? When do you get back in? Trying to time the market in this way is a fool's errand, and it only leads to more stress as you start to obsess over market news - what we call "financial pornography."
#3: Engagement in the Search for Alpha
Some financial advisors tout their ability to beat the markets, otherwise known as “alpha.”1 And many people want to believe that it can be done. However, in this search for “alpha,” our humanness — our emotions and our behaviors — may lead us astray. Ironically, studies done by DALBAR have calculated the “average investment return” as compared to active investor returns and have shown that the active investor returns are lower.1 While it is tempting to buy into the hype, especially when an active portfolio manager beats the market significantly over a short period of time, in the long run passive investments are the better option.
#4: Short-Term Anxiety and Focus
As humans, viewing aspects of our lives through the lenses of current circumstances is normal. One emotional response to any event, however, is letting the moment consume us, especially if faced with grave consequences — from our personal health being compromised to the loss of loved ones. Many may find it difficult in these times to both think long-term and to remember logic. However, making a rash decision can inhibit the long-term benefit that comes from maintaining a balanced perspective without reactionary behavior.
How to Lessen the Behavior Gap for Your Financial Health
At any given point, the market can go up, down or it can remain the same. While many aspects of the virus are out of our control, one thing we can control right now is how we handle our financial strategy.
In the past, the market has recovered in response to epidemics with an average of 17.17 percent over time.3 While no two situations are alike, remembering the likelihood of recovery over time — and the market’s nearly inevitable up-and-down movement — can provide a more logical angle to calm the nerves.
If you’re experiencing financial anxiety in response to the coronavirus pandemic, take a breath and remember that your financial plan was built to withstand downturns, even really bad ones. Of course, you can and should always reach out to us if you want to talk about things. We're here to help guide you away from the behavior gap and towards the boring, passive investment return strategy that we know will win out in the end.
This content is developed from sources believed to be providing accurate information, and provided by Twenty Over Ten. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.