Mind the Behavior Gap

Mind the Behavior Gap

April 27, 2021

It is nearly impossible to block out the noise, but it is imperative that you do so when it comes to investing! From the time our eyes open in the morning to the moment our heads hit the pillow, there is a constant stream of information coming at us like water from a fully opened fire hydrant. Buying any asset based solely on the fear of missing out (FOMO, for the uninitiated) and hoping that someone else will pay more for it in the future is hardly a solid investment thesis. The Greater Fool Theory1 states that you can make money from buying overvalued securities because usually someone (the greater fool) will come along and pay a higher price. Is that a gamble you are willing to make?

Building a successful investment portfolio does take a certain amount of skill, but more importantly it takes the ability to control our own worst enemy, ourselves! Investors tend to have underperformance from the investments they choose based solely on their own behavior. Carl Richards, CFP® and financial writer, calls this phenomenon the Behavior Gap2 , the difference between the return an investment produces compared to the lower return an investor actually earns.

Irrational decision-making causes people to get excited when things are going well and nervous when the world is not as rosy. The news is full of recent examples of manic buying behavior. Think of your favorite cryptocurrency or meme stock (a stock that has gone viral on social media, drawing the attention of retail investors). A recent article in the Wall Street Journal3 highlighted a young man who followed the rise of GameStop. Unable to restrain himself, he took out a personal loan paying more than 11% in interest to wager more than 20% of his net worth on the gaming retailer. This is not investing, it is gambling. Shortly after purchasing the shares the stock fell more than 80%. He is now left with high interest debt, a much lower net worth, and no plan of action going forward. FOMO got the best of him.

The opposite is also true, as we highlight in the Spring 2021 Ullmann Wealth Partners’ newsletter. The pandemic caused the economy to slow and created fear in the markets. Had you invested $1,000,0004 on January 1, 2020 and not checked back until New Year’s Eve, your investment would have grown to $1,183,989 returning 18.4%. Had you invested the same $1,000,000 but let yourself get undone by the 24/7 news media surrounding the market’s precipitous decline, you may have sold to wait for calmer days. Assuming the fear of the unknown was just too much to handle, and your investment was sold on March 23rd5, you were left with $694,994, a permanent loss of $305,006 and a negative 30.5% return. This emotional, knee-jerk reaction cost $488,955!

Letting emotions dictate your investment behavior will likely cause buying when prices rise only to sell when prices fall. Not only will this course of action be costly, not to mention completely irrational, but it could also very well ruin any chance of financial freedom. There has never been an investment textbook written that advises buying high and selling low. Unfortunately, when fear and greed take over, that is exactly what happens.

The most important questions you must pose to yourself are “Why am I investing?” and “What is important to me about money?” Some of the most common responses to these questions we hear from our clients are security, freedom, and peace of mind. If that is your answer, the next logical question is “How can I achieve these goals?” The first step is creating a well thought out financial plan that identifies not only your financial goals, but your life goals as well.

The next step is adopting an evidence-based investment philosophy supported by rigorous research. The philosophy will enable you to create an appropriate portfolio that gives you the highest odds of achieving your goals. The entire process must be flexible, but also systematic and free from emotion. Remember our panic seller back in March of 2020?

The final step is perhaps the most difficult, and that is executing the plan. Knowing what the future holds is not possible but recognizing exactly what to do with your investment portfolio when the unknowable happens provides the roadmap necessary to achieve your goals and ultimately your financial freedom.

Author: Brian James, CPWA®

Brian James is Director of Investments and a Wealth Advisor at Ullmann Wealth Partners. With more than 20 years of experience in the investment industry, he oversees the company’s investment management process which includes setting asset allocation, selecting investments and monitoring client portfolios. Brian earned an MBA at the University of Chicago’s Booth School of Business and is a Certified Private Wealth Advisor® professional.



3Some Game Stop Investors Bet Big, Lost Big Rachel Louise Ensign 2.16.21

4 Assumes $1,000,000 invested in iShares Core S&P 500 ETF

5 March 23, 2020 was the 2020 low for the iShares Core S&P 500 ETF