Understanding the behaviour gap in investing

By Morningstar |  10-10-18 | 

A gap exists between the rate of return an investment would earn in a fixed period, and the return an investor in reality earns from that very investment. The latter, more often than not, being much less as investors move their money around in an emotional response to whatever is happening in the market.

Carl Richards, author of The Behaviour Gap: Simple Ways to Stop Doing Dumb Things with Money believes that behaviour is what will eventually work for, or against, the investor.

Here are some learnings from his blog posts. You can access all the posts on BehaviorGap.com.

  • Even using a disciplined process and the best data we can find, “smart” activity often creates a behavior gap. The reality is that even if you own a mediocre investment, but if you behave correctly (sometimes that means doing nothing), you’ll outperform 99% of your neighbours. Outperforming your neighbour is not about finding better investments, it is about behaving better.
  • Once we’ve made a decision based on our personal goals and plans, often the best thing we can do is practice benign neglect. You never plant a tree and then pull it out every time the wind blows just to check the roots. I think you’ll find that trees grow much better when you stop looking at the roots all the time.
  • Investor behavior matters a lot. In fact, it probably matters more than skill. To understand why this is true, first you need to understand one fundamental concept: Investment returns and investor returns are almost always different.
  • Investment returns that you see in the paper or in marketing material are based on the assumption that you invest a lump sum at the beginning of the period, and then you leave it alone. You do not buy or sell. You do not change your mind and trade to another fund. You just buy once and hold.
  • Investor returns measure your real-life return. The return you earn as you buy and sell your investments, or switch from one investment to another in your search for the next hot thing.

Investment success is not about skill — it is about behaviour.

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