23 Jan, 2017

Behavior Gap

Today we are going to talk about an important concept called “Behavior Gap” and why it is so important for all investors to be aware of this. I really wish I had known this early in my career. Whenever I refer to investors in my writing, it will be assumed to be the average retail investor and not full time/professional investors, unless otherwise specified.

A few years ago I came across the DALBAR’s Quantitative Analysis of Investor Behavior (QAIB)DALBAR is a US based firm formed in 1976, which provides evaluation of investment companies, RIAs, broker dealers etc. They have been studying investor behavior for a while now now and keep updating their study every year. One of the key findings of this study is that an average investor under performs the popular benchmarks by a significant gap. This under performance or gap by an average retail investor is what is called “Behavior Gap”. 

It is called “Behavior Gap” because DALBAR discovered that 50% of the under performance arises due to “Voluntary investor behavior” which is the investing equivalent of an “unforced error” in tennis. Voluntary investor behavior generally represents panic selling, excessively exuberant buying and attempts at market timing.

The graphic below shows the gap between the average stock fund return and the actual return of an average stock fund investor over 20 years.

This is an extremely important insight. That almost half the gap can be bridged by modifying our own behavior. This means no blaming the market, advisors, or complaining that the market is rigged. You cant play the victim. Because you have met the enemy. And it is you.

Are you ready for the journey where over 20-30 years you will face many world changing events, many financial crises, Prime Ministers and Presidents will come and go, economies will rise and fall and so on. But you will ignore the noise and continue to diligently follow your investing plan. You will not get carried away by a rising market or be overly despondent if the market falls. You will not be lulled into boredom when the market does nothing. Or will you make “unforced errors” ?

Come to think of it, do you change your diet plan or exercise routine based on external factors or do you change it or follow it based on what works for you? You may say that this is not correct and that external events do affect the stock market and prices. This is a topic for another blog post.

Important Disclaimer: Please do not treat anything on our blog as investment advice. We do not provide any recommendations of any stocks or securities. Any stock mentioned may be merely by way of an example.