Fear and greed. These two emotions have more to do with investor returns than most people want to believe. Doing some research on the psychology of investing, I recently came across a great paper written by Carl Richards, the author of a personal finance blog called Behavior Gap.
Richards, a Certified Financial Planner (CFP) in Las Vegas, aptly describes the conundrum between investment returns and investor returns. Essentially, he noticed that “the real-life return of the average investor was dramatically lower than the return of the average mutual fund. In theory, this gap shouldn’t exist, but investors were leaving money on the table and didn’t seem to understand how it happened.” Richards calls this phenomenon the Behavior Gap™.
Data from Dalbar, a financial services industry research firm, supports Richards’ observations. According to Dalbar’s 2009 Quantitative Analysis of Investor Behavior (QAIB), throughout QAIB’s 15-year history, “which encompassed periods of unprecedented upswings as well as last year’s drop, the ‘average investor’ has continuously achieved 20-year results that lagged what the oft-quoted return statistics would lead investors to believe are achievable. Why? There is one simple reason: when the going gets tough, investors panic.”
Understanding the psychology of investing (often called behavioral finance) help us to better understand why investors often make buy and sell decisions that may not be in their best interests.
Click on the link below to read Richards’ paper and learn more.
I hope you enjoy Richards’ paper, and I welcome your feedback and thoughts. Call me at 602-281-4357 or email PEng@MoneyAZ.com.