Lessons From The Behavior Gap

“Investment mistakes are investor mistakes.” – Carl Richards

The Behavior Gap by Carl Richards is one of the best personal finance books I have read. And there is not a single specific investment idea in the entire book. No secret stock picking formula or perfect asset allocation by age and net worth. Instead, this book gives you the proper perspective on your money and financial decisions. What few of us seem to realize is that having the correct perspective on our finances is a prerequisite to being able to implement specific ideas correctly.

When Carl talks about the behavior gap what he is referring to is the difference between investment returns and investor returns. The difference between these two is where our actions and emotions come into play.

In fact, according to Vanguard founder John Bogle, the average equity mutual fund investment gained 173% from 1997 to 2011, but the average equity mutual fund investor earned only 110%. This is because we let our emotions control our investment decisions. This is our behavior gap.

Carl gives you countless pieces of wisdom throughout but I thought I would narrow them down to the most important lessons you can take from this book.

Lesson 1: Be honest with yourself.
We must be able to admit which emotion we succumb to more often, fear or greed. If you are nervous anytime the stock market corrects, it’s fear. If you can’t stand to sit out of a rising market and you are an aggressive investor, it’s greed. Make sure you know which one affects you more and develop an investment plan accordingly because using them both can cause you to sell at the bottom when you are scared and buy at the top when you are greedy.

You also need to understand that there are countless unknowns in the markets and economies you invest in. Knowing that factors are out of your control will help you make corrections to your process and adapt when your circumstances change.

We also must admit that there is no perfect investment out there, even when they constantly talk to you on CNBC about finding that one stock that is a sure thing. Coming to this realization can relieve a lot of stress from trying to be right all of the time. One of the reasons money managers constantly try to beat the market through active investing is the fact that they cannot be honest with themselves about the alternatives. This is even though countless studies show that over the long-term the majority of active managers don’t beat simple index funds.

Good financial advisors must also be honest. If you are going to entrust an advisor with the important job of managing your investments you must be able to trust that they have your best interests in mind. Are they open about conflicts of interest and do they manage them with the client in mind? There will always be some conflict of interest, so this is important. The advisor has to make money too so make sure that they are up front about how that happens.

Lesson 2: The beauty of simplicity.
We’ve all heard the phrase that less is more. But no one likes to use the simple choice. We assume that the complex investment strategy will work over the simple one because the really smart investment managers must have a good reason for charging such high fees for their investment ideas. Try not to overthink your finances. Simple is better for your long-term results and much easier to understand.

Here are some great lines from the book about keeping things simple:

Being slow and steady means you’re willing to exchange the opportunity of making a killing for the assurance of never getting killed.

Slow and steady capital is short-term boring.  But it’s long-term exciting.

We often resist simple solutions because they require us to change our behavior.

Most people look for the complex investments or solutions to their problems because it is easier than making meaningful behavioral choices. That’s why there are new fad diets and infomercial exercise equipment every year that offer to solve our health problems without mentioning that eating right and consistent exercise is the simple way to go about losing weight.

Lesson 3: Happiness is the key emotion.
We often talk about fear and greed being the investor’s two biggest enemies when investing. They cause you to buy high and sell low. But how do you combat these two irrational decision-makers? After reading this book it would seem to be happiness.

The book discusses a study that shows that having a good family life leads to more personal happiness than professional success does. Another study shows that money has a diminishing return on happiness up to around $75,000 a year in salary. So while money can buy some happiness, it only does so up to a certain point.

Carl goes on to discuss how most financial decisions are really just life decisions. Thinking in those terms could really change the way you view your money and your life. It helps to decide what it is that you really want to accomplish to make you happy by setting goals and focusing on why you would like to achieve them.

Lesson 4: We all make mistakes.
When dealing with complex investments and markets we are bound to make mistakes. Even the best investors do so on a regular basis. One of the most refreshing lessons I have picked up from reading Warren Buffett books and annual shareholder letters over the years is the fact that he admits to his mistakes and doesn’t shy away from them. He tries to learn from them.

Carl admits to some of his biggest financial mistakes in this book. He talks about having the discipline of staying out of technology stocks in the late-1990s tech bubble right up until 1999 when he finally capitulated. The stock he bought shot up immediately but within months came back down to Earth and he suffered a large loss. But he learned from the experience and uses it as a teaching point to this day.

He also got caught up in the real estate bubble in Las Vegas in the mid-2000s and had to stop paying his mortgage because he was upside down on his house (read more in this NY Times article).

Here is a well-known financial advisor that helps people make smart decisions with their money for a living, but even he got caught up in two of the biggest bubbles of the past 20 years. Only so many people can be the “smartest guys in the room.” Admitting you are not one of them and learning from your mistakes is a big step in the right direction towards making better financial decisions.

Don’t trust advisors that never admit their mistakes and are always blaming others either. It’s not investments that make mistakes but investors. It feels good to take credit for good investments but blame someone else when they go bad. Admit that mistakes happen and move on.

But What About Tactics?
You will eventually need the correct tactics to actually implement your process so I don’t want you to think I am downplaying that part of your investment plan. You need to open the correct accounts, set your asset allocation based on a number of factors, choose funds or securities to invest in and monitor your performance along the way.

But without the correct perspective on your finances and emotions it will be much harder to implement any of those tactics without committing mistakes that the majority of investors make on a regular basis (letting fear and greed take over, making decisions based on those emotions and not having a plan in place to aid in the decision-making process).

The Behavior Gap tells us that financial plans are worthless but the process of financial planning is extremely important. A plan assumes you know what’s going to happen in the future. Which we all know is next to impossible. But consistent planning assumes you admit things will be unpredictable and act accordingly.

A financial crisis can be hard to predict, let alone prevent. Just ask the Federal Reserve. Yet we all spend countless hours worrying about the next economic or stock market meltdown. We don’t spend quite as much time preparing for a personal financial crisis that you have much more control over.

Focus on the slow and steady long-term and avoid making decisions based on short-term emotions. Specific financial advice could be obsolete in a matter of hours, days or weeks while the correct perspective can last you a lifetime.


This content, which contains security-related opinions and/or information, is provided for informational purposes only and should not be relied upon in any manner as professional advice, or an endorsement of any practices, products or services. There can be no guarantees or assurances that the views expressed here will be applicable for any particular facts or circumstances, and should not be relied upon in any manner. You should consult your own advisers as to legal, business, tax, and other related matters concerning any investment.

The commentary in this “post” (including any related blog, podcasts, videos, and social media) reflects the personal opinions, viewpoints, and analyses of the Ritholtz Wealth Management employees providing such comments, and should not be regarded the views of Ritholtz Wealth Management LLC. or its respective affiliates or as a description of advisory services provided by Ritholtz Wealth Management or performance returns of any Ritholtz Wealth Management Investments client.

References to any securities or digital assets, or performance data, are for illustrative purposes only and do not constitute an investment recommendation or offer to provide investment advisory services. Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others.

The Compound Media, Inc., an affiliate of Ritholtz Wealth Management, receives payment from various entities for advertisements in affiliated podcasts, blogs and emails. Inclusion of such advertisements does not constitute or imply endorsement, sponsorship or recommendation thereof, or any affiliation therewith, by the Content Creator or by Ritholtz Wealth Management or any of its employees. Investments in securities involve the risk of loss. For additional advertisement disclaimers see here: https://www.ritholtzwealth.com/advertising-disclaimers

Please see disclosures here.

What's been said:

Discussions found on the web
  1. Stocks Will Go Down - A Wealth of Common Sense commented on Apr 25

    […] to the historical script and has one of the average declines we’ve seen in the past. You’re behavioral biases can affect your investment results so having a plan in place is one of the best ways to […]

  2. Paul LaVanway commented on Mar 30

    Wonderful quote relative to simplicity—and inadvertently—asset allocation…. “Being slow and steady means you’re willing to exchange the opportunity of making a killing for the assurance of never getting killed.”

    • Ben commented on Mar 30

      Agreed, that is a great example of a diversified asset allocation approach. Not an easy stance to take most of the time.

  3. Everyone Has a Plan Until They Get Punched in the Mouth commented on Oct 22

    […] big dip. This rarely turns out to be the case. Investors tend to buy high and sell low creating the so-called behavior gap. Like Mike Tyson once said, “Everyone has a plan until they get punched in the […]