Why are we such lousy investors? Episode 2: What the Behavior gap does to returns

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Why does the average investor earn returns far below the market return? In part two of this four-part series, we show exactly how ‘normal’ investor decision-making can turn a great investment into a poor return.

Video Script:

Why do most of us earn investment returns far below the market? Why are we such bad investors? In the first installment of this series I explained that our tendency to make poor financial decisions is innate: it comes from our ancestors. Today I'd like to explain to you just how that behavior leads to poor returns.

Imagine two great investments: they both go up 10% every year without fail. But you don't know that, so you decide to 'lock in' your return every year by selling one and then buying the other. What happens? Well first you pay a transaction fee and if it's in a taxable account, you pay taxes on the capital gain. So let's say you end up with only 8% of the 10% gain that you had. Then you buy the other fund. You do this every year, jumping from one to the other. After twenty years your investment would be 430% larger. Pretty good, but if you had stayed in one investment for all ten years and then sold it, your total after tax return would have been 580%. We call it "excessive trading" and it's one source of the behavior gap.

But it gets worse. When we jump out of an investment we almost never jump into another similar one. Instead, we 'sit on the sidelines' with money in low yielding money market accounts for 2, 4, 6 months before we reinvest it. The result? We lose the benefit of the time that our money could have been working for us. By waiting just 3 months to reinvest the money each year in our example, the ten year return falls from 430% to 353%.

But it gets even worse than that. I'll let you in on a little secret: there are no perfect investments. It's much more likely that our two investments will swing up and down in value depending upon circumstances and market sentiment. So lets say they rise 20 percent and then fall 10 percent every year. Our tendency to pay too much attention to our neighbors leads us to buy when it's rising and sell when it's falling - after all, that's the reason it rises and falls so much: everybody's doing it. This tendency to do what the crowd is doing is euphemistically called 'momentum' investing, but the momentum it provides to the typical investor is usually down.

Excessive trading, sitting on the sidelines and following the crowd: three  ways to reduce your investment returns because of the behavior gap.

Why are we such lousy investors? Episode 3: Closing the behavior gap

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Why does the average investor earn returns far below the market return?  In part three of this four-part series, we describe several strategies that investment advisors use to help their clients avoid the pitfalls of poor returns.

Video Script:

Why do most of us earn investment returns far below the market?  Why are we such bad investors?  In the first installment of this series I explained that our tendency to make poor financial decisions is innate:  it comes from our ancestors.  In the second session I showed you how our behavior hurts investment returns.  Today I'd like to share with you some strategies that financial planners use to close this behavior gap.

The first strategy is diversification.  A diversified portfolio is composed of many different asset types like stocks and bonds, and also different securities within a type like GE versus Exxon.  The idea is that while all of these assets will fluctuate in value, they will do so at different times and at different rates so that the swings will tend to cancel each other out, making the overall portfolio fluctuations smoother. A Diversified portfolio does not guarantee a profit or protection from losses in a declining market. Therefore, the benefits of diversification will hold only if the securities in the portfolio do not react to market events in a similar fashion.

Advisors also use the 'tea saucer' strategy.  Just as people used to pour their hot tea into their saucer to cool it off, your advisor encourages you to route all trades and transactions through him or her.  The result is that you always have a conversation with someone who is well informed and less emotionally involved before making a move.

Finally, financial planners make sure that your mix of investments is appropriate for both your psychological and financial health.  They work hard to ensure that the riskiness of investments is appropriate for you and your circumstances and to set expectations for the volatility you should experience.  Knowing what to expect helps us to better manage our emotional response to events.

At the end of the day you make the decisions for your investment future.  Your advisor's job is to make sure that you have the best possible information and advice available when you need it.  All the better to keep that inner cave person at bay.

IFG Interview

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Recently I was asked a few questions about our partnership with Integrated Financial Group and the role I play as a financial advisor.  Here’s what I said:

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Recently, was asked a few questions about partnership with the Integrated Financial Group.  

First of all, what exactly is Integrated Financial Group?

IFG is a consortium of top independent financial planning and personal investment management firms located in cities throughout the nation who have joined together to provide the industry’s best tools, solutions and expertise to our clients.

How do you get to be a member?

IFG chooses its members from among the top 10 percent of financial advisory firms in the nation.  To be selected, a firm must already be a leader in their own community and have a reputation for competence and integrity.  So you can see that we're very pleased to be chosen.

What makes the combination of and IFG different than a big brand name brokerage?

Independence WITH expertise.  IFG members are completely independent of all external pressures to sell this product or move that security.  With IFG we have the ability to leverage some of the top talent in the industry - each IFG member brings a particular set of expertise that the entire group can leverage.

How does that difference translate into value for your clients?

First, they have our total attention – they know that we’re not focused on hitting the next bonus level or winning that trip to Maui, because we don’t have those things.  Second, our advice is completely independent – we have the total freedom to do what’s best in a client’s particular circumstance without having to consider any corporate goal.  And we do this while offering our clients access to the highest quality services, products and expertise usually associated only with mega-firms.

Anything else that our audience should know about you and IFG?

The only way to determine if a financial advisor is a good fit is to sit down with them and talk about it.

How can someone get in touch with you if they would like to learn more?

You can contact me at or telephone me on xxx.xxx.xxxx.