How Could the Behavior Gap Affect Your Investments During This Time of Market Volatility?

One author who I enjoy reading frequently is Carl Richards. Carl's main audience is financial advisors like myself. He has the rare ability to make complex financial concepts easy to understand and frequently does this through his sketches. As a matter of fact, my office walls are home to a half a dozen of his sketches. This one is extremely apropos for the market environment that we are currently experiencing.

They say that a picture is worth a thousand words. In the case of Carl's sketches, they are worth even more. This simple sketch forcefully explains the problem with selling after the market falls and waiting to get back in when "things look better". You are in fact selling low and buying high. This is a recipe for failure. You should be doing the exact opposite - buying low and selling high! So when someone asks me, "Is now the time to buy stocks?" More often than not my answer is, "Yes!"

“It turns out my job was not to find great investments, but to help create great investors,” writes Carl Richards, author of “The Behavior Gap.”¹ From increasing our budget mindfulness to taking a steadier approach to investing, Carl 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. In the past few weeks, the Coronavirus is one such event that has affected nearly every industry and home as people and governments take action to keep themselves and their communities safe. The virus continues to evoke fear and panic as the number of impacted individuals rises. 

The stock market volatility of 2020 began on Monday, March 9, with history’s largest point plunge for the Dow Jones Industrial Average. On March 16, 2020, the Dow hit a new record. It lost 2,997.10 points to close at 20,188.52, demonstrating the financial effect of this health crisis.² 

Whether facing a devastating event or an exciting advancement, people frequently make money decisions as a response. Below I discuss the common financial behaviors driven by such circumstances.

The Behavior Gap Explained 

Coined by Carl, “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 new product release, many investors may feel tempted to increase their risks or attempt to gain from emerging investments when stocks are high. This exuberance 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.

"Markets can remain irrational longer than you can remain solvent." - John Maynard Keynes

#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.² 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,” investors' humanness — their emotions and their behaviors — usually end up leading them astray. Frequent studies done by DALBAR, calculate  “average investment returns” and compare them to investors' actual returns. Ironically, their studies reveal that the investor returns are lower.¹ The underlying emotional desire and pursuit of money ends up being  the recipe for unwise behaviors in response to human emotions. 

#4: Short-Term Anxiety and Focus

As human beings, we normally view aspects of our lives through the lenses of our current circumstances. One emotional response to any event, however, is letting the moment consume us. This is especially true if we are faced with grave consequences —  from our personal health being compromised to the loss of loved ones. Many may find it difficult during these times to think both long-term and logically. However, making a rash decision can inhibit the long-term benefit that comes from maintaining a balanced perspective without the reactionary behaviors. 

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 affairs and stick to our financial plan. 

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 movements — can provide a more logical angle to help calm the nerves. 

If you’re experiencing financial anxiety in response to the coronavirus, take a breath and also remember the potential for long-term gains. Of course, you can and should always reach out to your financial advisor for further clarification and advice specific to your circumstances.