In a recent article, Bloomberg writer and financial blogger Barry Ritholtz was discussing the significant difference between the returns that an investment earns, and the actual returns that investors get. Here is an example: As of 12/31/2013, the S&P 500 Index over the past 20 years returned on average 9.22% per year. The average equity investor earned just over half of that.
Financial Planner Carl Richards recognized this phenomenon and labeled it “the Behavior Gap.” The gap is the return the investor didn’t capture and left on the table. Carl Richards found that the gap was not due to poor investment choices, but by taking the wrong action at the wrong time.
A fundamental market principal is to buy low and sell high. It seems so basic and simple, but in reality, it is hard to do. People are not always rational when it comes to financial matters. Think about the recent past. When did everyone think about buying gold? When gold was already up 60%. When do we see the inflows into equity funds? When equity funds are up significantly in value. When the market goes down, we see worry and fear take over and people sell their holdings. In these very real scenarios, emotions are propelling investors to take action – action that results in buying high and selling low. This is absolutely contrary to what is in our best interest.
There is talk of investment bubbles abounds in the media. While we do not think that the equity market is overvalued, given where we are in the market, it would not be a surprise to see a correction. We are not predicting a correction or saying one is coming soon or very soon. We simply recognize the market is not summer and sunshine all of the time. There are those expected rainy days and cold seasons for which we should plan.