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

It can be daunting when attempting to invest in a market as volatile as it is. Understanding the behavior gap will give you confidence and ease your worries.

COVID, along with other factors, have made the market volatile, and investing now can be dangerous. Learn how invest wisely!

 

“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, Richards has drawn attention to the way our unexamined behaviors and emotions can be to 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. 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 amidst its inevitable, unpredictable movement.

#2: Fear When Stocks Are Low

In response to market volatility, investors may 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. 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 coronavirus, take a breath and also remember the potential for long-term gains. For more information on how to securely invest during a time of volatility. feel free to reach out to our team of advisors at California Retirement Advisors for further clarification and advisement. 

By Christian Cordoba
CERTIFIED FINANCIAL PLANNER™
Founder, California Retirement Advisors