“All through time, people have basically acted and reacted the same way in the market as a result of: greed, fear, ignorance, and hope.”

Jesse Livermore

Recently, I read that multiple studies have shown that when the stock market goes up, investors’ money flow into it. And when the market goes down, investors’ money flow out of the market.  This type of behavior would be like a shopper heading to the grocery store every time the price of produce goes up and then returning the produce to the store when it goes on sale – but the store will only buy it back at the sale price. 

This behavior of buying high and selling low results in investors market returns to be substantially less than historical stock market returns.   

Behavior Gap is the difference between an investment’s return and an investor’s actual return. The “gap” is where investors’ behavior—their actions and emotions–come into play.  Without investor’s emotion, the difference would be minimal between what the investor would have earned in compared to what they actually saw in their investment account. 

According to Vanguard founder, the legendary investor Jack Bogle, the average equity mutual fund investment gained 173% from 1997 to 2011, but the average equity mutual fund investor earned only 110% during the same period. From their analysis, this gap is directly attributed to investors allowing their emotions of “greed, fear, exuberance or despair” to control their investment decisions.  

Additionally, every year since 1994, Dalbar’s Quantitative Analysis of Investor Behavior (QAIB) has measured the 20-year average annual compound rate of return for the average large cap equity mutual fund in the U.S. and the average return realized by equity mutual fund investors.   

For the 20 years through 2007, Dalbar’s QAIB results demonstrated that the average equity fund produced 10.81%, and the average equity fund investor produced 4.48%. From the analysis, it is apparent that over the 20 year span, the average fund investor consistently realized much less investment return than the return of the average fund.   

“People have a tendency to sell at the bottom when the market is at its worst and buy at the top when the market is at its best. Inherently, this leads to poor investment returns.”

Carl Richards

Additionally. According to Dalbar, most investors took performed poorly in the second half of calendar year 2018 — in fact investors averaged a loss of 9.42% — compared with the S&P 500, which had a loss of 4.38%.  And, during October 2018, in which the S&P 500 was down 6.84% while the average equity investor return was down 7.97%; and in August, when the S&P 500 was up 3.26% and the average equity investor was up only 1.80%.  The QAIB research concluded that the average investor didn’t have much success whether the market was good or bad in 2018. 

In a January 2012 Forbes interview, Carl Richards, author of the  book, The Behavior Gap: Simple Ways to Stop Doing Dumb Things with Money, pointed out that investors are “…responsible for their behavior.”  He states that investors are responsible for spending less than they earn; to saving and investing with discipline. Further, he states that it has become easier for investors to blame banks, Wall Street, credit card companies, politicians, etc., for their financial mistakes…but blaming others does alter the impact their own behavior has on investment account. Thus, it’s better for investors to own up to their responsibility and learn from their mistakes. 

Fortunately, there are several actions investors can take to protect themselves from making emotional decisions during times of eye raising market volatility and to reduce the impact of the Behavior Gap on their investment accounts.   

• First, investors can stay true to their long range financial plan and make a conscious decision to do nothing since short term market volatility should not matter.   
• Secondly, they should never sell or have any reason to sell stocks in a down market.  If an investor’s portfolio is properly allocated and they have set aside three to six months of living expenses in an emergency fund, they should be able to ride out short term market volatility.  
• And, finally, investors can seek professional help and confer with a financial adviser. If an investor is unable to control their emotions, they should not be investing on their own.