Carl Richards, author of “The Behavior Gap” wrote:
“It turns out my job was not to find great investments, but to help create great investors.”
The behavioral aspects of finance and investing are something Richards has done a wonderful job examining and passing along to advisors and investors. Managing cash flows, remaining steady with investments, and being mindful of spending are all areas that he’s focused on and helped investors with.
When we become emotional, anxious, or nervous, we tend to make poor financial decisions. The COVID-19 crisis of 2020 has been a massive event affecting every inch of our lives and every industry in the world. The virus continues to evoke fear and uncertainty throughout the markets and our personal lives.
We saw unprecedented volatility in the markets during February, March and April. On Monday, March 9, with history’s largest point plunge on the Dow. On March 16, 2020, the Dow lost 2,997.10 points, demonstrating the financial impacts of this health crisis.
This pandemic was the most recent example, but whether it’s fear-inducing news or an exciting new accomplishment, we tend to make emotional responses with our money. Below we discuss the common financial behaviors driven by such circumstances.
What is the “Behavior Gap”?
Coined by Richards, “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 had they not made an emotional decision.
What Causes the “Behavior Gap”?
#1: Excitement From Good Markets/Good News
Many investors may feel tempted to increase their risk or capitalize on rising stocks when stocks are moving higher (aka ‘performance chasing’). This can lead to investors constantly readjusting their portfolios as the market moves higher. An investor who follows such patterns is likely to do the same with declines. This is a clear form of trying to time the market. While even a broken clock is right twice a day, trying to consistently nail tops and bottoms in the market is a fool’s game.
#2: Fear From Bad News/Bad Markets
As a response to COVID-19 and the market volatility that ensued, we saw a lot of investors flee to safer investments or move out of the market completely. All-in or all-out decisions in the market is hardly ever a good idea, and caused investors to miss the subsequent recovery. When stocks are low, a common response may be to sell and effectively miss out on potential long-term gains. The same thing seems to be happening now with the impending election. Moving to cash to “wait out” the election results is not an appropriate form of risk management.
#3: Trying to “Beat the Market”
Many investors seek the help of a financial advisor to achieve above-average returns and “beat the market”, otherwise known as “alpha.” However, in this search for “alpha,” our humanness — our emotions and our behaviors — may cause us to do the exact opposite. Ironically, studies done by DALBAR have calculated the “average investment return” as compared to investor returns and have shown that investor returns are lower.
#4: Focusing on the Day-to-Day
Sometimes it’s hard to focus on the bigger picture when things are running haywire in the short-term. It’s easy to get caught up in “today” and lose sight of “tomorrow”. However, making a rash decision can inhibit the long-term benefit that comes from maintaining a balanced perspective without reactionary behavior. Your investments will thank you for trying your hardest to keep the end game in mind.
How to Not Fall Victim to the Behavior Gap
The stock market is going to go up. It’s going to go down. For long periods of time, the market will seemingly go nowhere. All of these are okay. In regards to the current crisis of COVID-19, many aspects are out of our control, but one thing we can control right now is how we handle our financial strategy.
If you’re experiencing financial anxiety in response to the pandemic or potentially the presidential election, take a breath. Remember the potential for long-term gains. Of course, you can and should always reach out to your advisor for further clarification and reassurance. For those without an advisor, we’d be happy to speak with you at Mullooly Asset Management. You can click here, or here to schedule an initial call with one of our advisors.