The Behavior Gap: Why Investors Earn Less Than the Funds They Own
The Behavior Gap: Why Investors Earn Less Than the Funds They Own
COACHING POINTS
- The Problem: There is a measurable difference between the return of an investment (e.g., the S&P 500 Index) and the return of the average investor holding that investment. This shortfall is called the Behavior Gap.
- The Cause: The gap is driven by psychology. Investors tend to buy when markets are hot (Greed) and sell when markets crash (Fear). This “buy high, sell low” timing destroys compounding.
- The Solution: You cannot control the market, but you can control your behavior. The only way to close the gap is through systematic automation (DCA) and a rigid written investment policy that prevents emotional decisions.
“The investor’s chief problem—and even his worst enemy—is likely to be himself.” — Benjamin Graham. Data consistently shows that while the stock market generates wealth over time, the average investor captures only a fraction of it. This isn’t because of high fees or poor stock picking; it’s because they can’t sit still. Source: Dalbar QAIB Report (Quantitative Analysis of Investor Behavior)
Scenario: 20-Year Annualized Returns (Ending Dec 31, 2019).
- S&P 500 Index Return: 6.06%.
(A passive buy-and-hold strategy would have earned this). - Average Equity Fund Investor: 4.25%.
(The actual return captured by real people moving money in and out). - The Gap: -1.81% per year.
Over 20 years on $100k, this gap costs you nearly $100,000 in lost wealth. It is mathematically equivalent to paying a massive extra management fee.
What-If Scenario: Missing the Best Days
Comparison: Staying invested vs. Trying to time the market (1990-2020).
| Strategy | Annual Return | Result |
|---|---|---|
| Fully Invested (No Selling) | 10% | Wealth Compounded. |
| Miss Best 10 Days | 7% | Returns cut by ~30%. |
| Miss Best 30 Days | 2% | Returns barely beat inflation. |
Visualizing the Gap (20-Year Avg)
| Return Type | Annualized Return (%) |
|---|---|
| S&P 500 Index | 6.1 |
| Average Investor | 4.3 |
| Inflation | 2.2 |
*The average investor barely beats inflation despite taking equity risk. The gap is purely behavioral cost.
Cost of Behavior on $100k (20 Years)
| Scenario | Ending Balance ($) |
|---|---|
| Market Return (Buy & Hold) | 320000 |
| Investor Return (Emotional) | 230000 |
*Emotional trading erodes nearly $90,000 of wealth in this scenario. The “Behavior Gap” is the most expensive fee in finance.
Execution Protocol
Remove the “Buy” button from your life. Set up automatic monthly transfers from your bank to your brokerage. If you have to manually log in to invest, you will inevitably hesitate when headlines are bad.
The more frequently you check your balance, the more volatility you see, and the more likely you are to act irrationally. Checking once a year (for rebalancing) yields better behavioral results than checking daily.
Write an Investment Policy Statement (IPS). “I own 80% Stocks / 20% Bonds. I will rebalance if bands drift by 5%. I will never sell during a drawdown.” Read this when you are scared.
COACHING DIRECTIVE
- Do This: Be boring. The best investors are often those who forgot the password to their account. Optimism and patience are your edge.
- Avoid This: Tuning into financial news media (CNBC/Bloomberg) for trading advice. Their job is to sell ads by triggering your Fear and Greed. Your job is to ignore them.
Frequently Asked Questions
Can I time the market?
Statistically, no. To time the market successfully, you must be right twice: when to get out (the top) and when to get back in (the bottom). Missing just one of these turns destroys your returns.
Does hiring an advisor help?
Yes, this is the primary value of a financial advisor. Vanguard estimates “Behavioral Coaching” adds about 1.5% to net returns simply by preventing clients from panic-selling during crashes.
What is Recency Bias?
It is the psychological tendency to believe that what happened recently (e.g., a market crash or a tech boom) will continue indefinitely. It causes investors to chase performance at the top and sell at the bottom.