Source: The Behavior Gap by Carl Richards
The last few years I have read from different sources that this is the best time in history to be an investor. Investment expenses have dropped precipitously for several decades now. The choices at our disposal to build a portfolio seem limitless. Want a fund that tracks the stock market of Chile? No problem. How about just the small companies of India? Done. And how could we live without a fund that gives us 3 times the daily performance of the financial sector? You don’t have to wait for your monthly statement to see your account value. Check everyday if you want, or every hour.
Strategies that for a long time were only available to the ultra wealthy, are now available to many Americans. The amount of information at our disposal to make prudent investment decisions is easily accessible for free. There are hundreds of investment podcasts, thousands of online investment discussion forums, approximately 80,000 CFP® professionals, account aggregation tools which make it simple to track all of your assets in one place, and to top it all off I believe we have been in a tremendous bull market.
Has all of this made people better investors? Let’s look at some evidence…..
As of 12/31/2017 the S&P 500 Total Return Index returned 8.50% annually over the prior ten years (Source: Morningstar Advisor Workstation). For the largest fund that tracks this index, investors in the fund only earned 3.95% per year (Source: Morningstar Advisor Workstation). This gap between investor returns and the investment return is commonly referred to as “the behavior gap” (see picture above). Other studies have shown of a similar sized behavior gap going back many years.
Research posted by financial advisory firm IFA in July of 2015 studied the returns from 652 of their clients during the period 01/01/2008 – 12/31/2014. The research showed that 176 of those clients did not follow the firm’s advice and either decreased their stock allocation by more than 25% or increased it by more than 10% at some point during the time period. That group of clients only earned 69.40% of the benchmark return. Another group of 276 clients followed the firm’s advice and did not increase or decrease their allocation to stocks by more than 9%. That group of clients earned 101.63% of the benchmark return.
With all of the educational resources out there for free, why would such a gap in returns continue to exist?
- Unless someone has a true interest in finance, money, and investing, they are unlikely to dedicate the time to learning about it and will be more prone to making decisions on their “gut feelings” rather than an evidence-based decision.
- Other people do have a genuine interest in finance, but it can be hard to find the right places to look and the right people to listen to for education. They may accidentally end up at a free dinner retirement seminar for a product pitch or reading online discussion forums on how to day trade effectively, which may not be appropriate for them.
- Some are hesitant to hire a professional advisor. This could be from overconfidence in their own skillset, or simply not wanting to pay anyone. Good advice is not always the cheapest, but bad advice could cost someone dearly.
- Even those with advisors can bail on a well thought out investment plan if they feel it was not explained correctly and expectations were not set properly.
- Emotions. Money is emotional. Watching an account balance drop causes concern, or watching it go up may inspire greed. Taking action on your investments just because everyone else is, may not be a sound decision. Rules-based decision making has many benefits, and one is helping remove emotions from the equation.
If we all viewed our investments in the stock market similar to how we would view an investment in land, we would more than likely help narrow the behavior gap. A piece of land is not valued everyday or even every year, nor would you care to have it valued that often. Unfortunately, having access to second by second updates is a constant strain on your emotions. Being dragged into that type of routine could be very damaging to one’s lifetime investment returns.
The resources available to investors are more robust than ever before, and at a lower cost than ever before. Having said that, there does not appear to be evidence yet that individuals are becoming better at keeping more of their returns.
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The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Investors may not make direct investments into any index. Past performance may not be indicative of future results. Individual investor’s results will vary.