How Could the Behavior Gap Affect Your Investments During This Time of Market Volatility?
“It turns out my job was not to find great investments, but to help create great investors,” writes Carl Richards, author of “The Behavior Gap.” From increasing our budget mindfulness to taking a steadier approach to investing, Richards has drawn attention to the way our unexamined behaviors and emotions can be to our detriment when it comes to living a happy and financially sound life.
In many cases, we make poor financial decisions when experiencing panic or anxiety as a result of personal or widespread events. Below we discuss the common financial behaviors driven by such circumstances.
The Behavior Gap Explained
Coined by Richards, “the behavior gap” refers to the difference between a smart financial decision versus what we actually decide to do. Many people miss out on higher returns because of emotionally driven decisions, creating a gap — “the behavior 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
Whether in a bull market or witnessing the hype from a product release, many investors may feel tempted to increase their risks or attempt to gain from emerging investments when stocks are high. This can lead to investors constantly readjusting their portfolios as the market itself experiences upswings. An investor who follows such patterns is likely to do the same with declines and may end up trying to time the market amidst its inevitable, unpredictable movement.
#2: Fear When Stocks Are Low
In response to market volatility, investors may feel the need to choose more secure investments and avoid uncertain or seemingly unsafe investments. When stocks are low, a common response may be to sell and effectively miss out on potential long-term gains.
#3: Engagement in the Search for Alpha
People yearn to make money and take action to do so. Throughout our lives, this emotional desire is likely a constant one. As such, many seek the help of a financial advisor to procure above-average returns, otherwise known as “alpha.” However, in this search for “alpha,” our humanness — our emotions and our behaviors — may lead us astray. Ironically, studies done by DALBAR have calculated the “average investment return” as compared to investor returns and have shown that investor returns are lower. The underlying emotional desire and pursuit of money is exactly the recipe for unwise behaviors in response to emotions — but only if left unchecked.
#4: Short-Term Anxiety and Focus
As humans, viewing aspects of our lives through the lenses of current circumstances is normal. One emotional response to any event, however, is letting the moment consume us, especially if faced with grave consequences — from our personal health being compromised to the loss of loved ones. Many may find it difficult in these times to both think long-term and to remember logic. However, making a rash decision can inhibit the long-term benefit that comes from maintaining a balanced perspective without reactionary behavior.
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 markets are out of everyone's control, one thing we can control right now is how we handle our financial strategy. 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 recent market volatility, take a breath and also remember the potential for long-term gains. To discuss in more detail, feel free to reach out to us.
CRA Investment Committee
Matt Reynolds CPA, CFP®
Tom Reynolds, CPA
Robert T. Martin, CFA, CFP®
Gordon Shearer Jr., CFP®
Jeff Hilliard, CFP®, CRPC®
Joe McCaffrey, CFP®
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