I’ve been a big fan of Carl Richards, the New York Times Sketch Guy and financial planner, since I stumbled upon his work in 2009. His illustrations and insights are both simple and impactful when it comes to investment and planning concepts. A great example is the Behavior Gap.
Financial research firm DALBAR produces the Quantitative Analysis of Investor Behavior (QAIB) report annual; it has been the nation’s leading study on investor behavior for 27 years and has shown a consistent and regular outcome regarding stock market returns and average equity fund investor returns. Though the numbers may vary from one year to the next, the clear and critical message holds true – investment returns are consistently greater than investor returns. This difference is what Carl Richards has termed the Behavior Gap and shows clearly in the sketch below.
Why does the gap exist?
The typical stock market investor, unfortunately, buys high when things are going well and sells low when the markets drop. This behavior causes the gap in long-term returns.
Another one of Richards’ sketches (below) illustrates the unfavorable pattern that causes the Behavior Gap. It depicts what happens when we allow emotions, such as greed and fear, to take over the decision-making process for our portfolio. This pattern leads to the type of underperformance that many average investors experience.
As the sketch suggests, making rational decisions about our investments is not automatic for most people, especially in volatile markets. It takes a certain mindset or temperament, along with a well thought out investment plan to avoid this situation.