The Behavior Gap Is Real, and It Can Be a Major Player in Your Investment Decisions. During Times of Market Volatility, Be Aware of These 4 Emotions
“It turns out my job was not to find great investments, but to help create great investors,” writes my colleague, Carl Richards, author of “The Behavior Gap.”1 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 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. Over the course of last year, the Coronavirus is one such event that has affected nearly every industry and home as people and governments continue to take action to keep themselves and their community safe. The virus continues to evoke fear and panic as the number of affected individuals rises.
The stock market volatility of 2020 began early in in the year. On Monday, March 9th, the Dow fell 7.79%. What some labeled as Black Monday 2020 was, at that time, the Dow’s worst single-day point drop in U.S. market history. On March 12th, the index fell a record 2,352.60 points - a 9.99% drop - almost a correction in a single day. It was the sixth-worst percentage drop in history. Then on March 16th, the Dow plummeted - a 12.93% free fall - exceeding the original October 1929 Black Monday slide of 12.82% for one session.
Whether facing a devastating event or an exciting advancement, people frequently make money decisions as a response. 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 time and again amidst its inevitable, unpredictable movement.
#2: Fear When Stocks Are Low
As a response to the Coronavirus, the market has seen losses as many investors 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.”1 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.1 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 virus are out of our control, one thing we can control right now is how we handle our financial strategy.
In the past, the market has recovered in response to epidemics with an average of 17.17 percent over time.3 While no two situations are alike, 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 the recent volatility, or have questions about progress to achieving your goals, it may be a good time for a second opinion on your current financial plan. Of course, you can always reach out to us to confidentially discuss your individual situation.
Beacon Hill Private Wealth is an independent, fee-only, fiduciary investment advisor providing evidence-based wealth planning solutions that simplify our clients' financial lives. Founder Tom Geoghegan, CFP® CPWA® MBA is also a member of the National Association of Personal Financial Advisors (NAPFA).
Why work with a credentialed advisor? The Certified Private Wealth Advisor® (CPWA) certification, administered by the Investments & Wealth Institute®, is the standard for competence in the field of wealth management today. The advanced credential created specifically for wealth managers working with high-net-worth clients is focused on the life cycle of wealth—accumulation, preservation, and distribution. CPWA certified professionals are able to identify and analyze the unique challenges high-net-worth individuals face and understand how to develop specific strategies to minimize taxes, monetize and protect assets, maximize growth, and transfer wealth. The CPWA designation signifies that an individual has met initial and on-going experience, ethical, education, and examination requirements for the professional designation, which is centered on private wealth management topics and strategies. Fewer than 1% of financial advisors have achieved the CPWA certification.3
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