Author Carl Richards wrote in his book “The Behavior Gap” that ‘It turns out my job was not to find great investments, but to help create great investors’. What we often find in financial planning and investment management is that a key obstacle to living a happy and financially sound life is our personal emotions and the resulting behaviors. This is one reason our firm has devoted much study lately to the tools of Behavioral Finance.
Panic often leads to poor financial decisions. One such example is evident these past many weeks as the nation and the world deals with the Coronavirus pandemic. The ripples of this event are felt in nearly every industry, every home, and every government. To keep our families, workplaces, and communities safe some remarkable actions have been undertaken. As the number of cases continues to rise, the virus continues to evoke fear and panic.
Looking back on the markets for March 2020, it was a wild ride. On March 9 the Dow Jones Industrial Average recorded it’s largest one day point decline. One week later, the index beat that record with a further plunge totaling 2,997.10 points to close the day at 20,188.52. Whether the event is devastating or exciting, people make financial decisions as a result.
The Behavior Gap Explained
According to Carl Richards, “the behavior gap” is the difference between a smart financial decision and what we actually decide to do. Many people miss out on higher returns because of emotionally driven decisions, creating a 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
In times when stocks are high, many investors feel tempted to increase their risk and attempt to gain from emerging investments. These investors tend to constantly readjust their portfolio as the market swings upward, always jumping on a new bandwagon. The same investors tend to act similarly when markets are declining, trying to time the market again and again against the inevitable, unpredictable movements. Chasing investment returns is rarely a winning strategy and you can temper excitable moves by having a plan and sticking to it.
#2: Fear When Stocks Are Low
As we have seen in March 2020 with the Coronavirus, the market’s losses continued to steepen through the month as investors sought more secure investments and to avoid seemingly uncertain investments. When stocks are low, and investors choose to walk away, they effectively miss out on potential long-term financial rewards.
#3: Engagement in the Search for Alpha
Alpha, in the investment space, means ‘above-average returns’. In the constant pursuit of wealth, investors hope to procure alpha, often through partnership with a financial advisor. The search for alpha is often led astray by our emotions and behaviors. A most interesting finding by DALBAR is this: investor returns are actually lower than the so-called “average investment return”. Unchecked, emotional financial decisions in the pursuit of investment return and alpha are exactly the recipe to produce inferior returns. Work with an advisor that coaches you through your emotional reactions to the market and your personal pursuit of wealth.
#4: Short-Term Anxiety and Focus
Have you ever made an irrational decision? A knee-jerk reaction you went on to regret? When we let a moment consume us, especially a moment with potentially grave circumstances, we forget to think with logic. When we stop thinking logically, we stop thinking long-term and we tend not to make decisions based in our best interest. If we eliminate and control reactionary behavior, especially in our finances, we can reap long-term benefits.
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.
While no two market 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, take a breath and remember the potential for long-term gains. Of course, you can and should always reach out to your advisor for further clarification and advisement.
Past performance is no guarantee of future returns. Investors cannot invest directly in an index. Diversification and asset allocation do not guarantee returns or protect against losses. The information given herein is taken from sources that IFP Advisors, LLC, dba Independent Financial Partners (IFP), IFP Securities LLC, dba Independent Financial Partners (IFP), and it advisors believe to be reliable, but it is not guaranteed by us as to accuracy or completeness. This is for informational purposes only and in no event should be construed as an offer to sell or solicitation of an offer to buy any securities or products. Please consult your tax and/or legal advisor before implementing any tax and/or legal related strategies mentioned in this publication as IFP does not provide tax and/or legal advice. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situation, or needs of individual investors.
Securities offered through IFP Securities, LLC, d/b/a Independent Financial Partners (IFP), member
FINRA/SIPC. Investment advice offered through IFP Advisors, LLC, d/b/a Independent Financial Partners
(IFP), a Registered Investment Adviser. IFP and Callesen Wealth Management are separate entities. The information contained in this message may be CONFIDENTIAL and is for the intended addressee only. Any unauthorized use, dissemination of the information, or copying of this message is prohibited. If you are not the intended addressee, please notify the sender immediately and delete this message.