The Behaviour GapPrashant Vaishampayan
Coined by Carl Richards, “the behaviour gap” refers to the difference between smart financial decisions versus what we actually decide to do. Many people miss out on higher returns because of emotionally driven decisions, creating a gap — “the behaviour 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. 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.
#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 behaviours — may cause us to do the exact opposite.
#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 behaviour. 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.