Mind the behaviour gap

How to avoid sacrificing 36% of your savings




BUYING HIGH AND SELLING LOW ARE TWO OF THE MOST COMMON MISTAKES THAT INVESTORS MAKE

It is a familiar story: when times are good, investors buy in near the top of the market – buoyed by positive sentiment and a fear of missing out. Then, when things turn sour, they sell in the midst of a bear market or crisis. It happens time and time again because investment decisions are driven by emotion.

Quentin Marshall, Head of Weatherbys Private Bank says:

“What investors may not realise is the scale of damage that buying high and selling low can have on their portfolio. Author Carl Richards coined the phrase the ‘behaviour gap’ to describe the difference between the returns an active investor actually takes home versus the performance of a lump sum that is invested in the market and simply left over time. This means staying invested through the highs and lows, and avoiding the temptation to tinker. Data shows that far from adding value, midjudged investment decisions cause an investor's returns to lag the market."

John Butters, Chief Investment Officer at Weatherbys Private Bank, says:

“This behaviour can make a huge difference. Research by Betterment finds an estimated behaviour gap of between 1.2% and 4.3% a year. In other words, equity investors on average give up somewhere between 11% and 36% of their savings over ten years by making bad decisions.
 
“For an investor in global equities, a behaviour gap of 4.3% would make a huge difference to returns over time. The chart below shows the performance of a global equity ETF in the ten years to the end of August 2018, together with the return an investor would have achieved if bad decisions had added a drag of 4.3% per annum. The difference in total returns is enormous: returns fall from 174% to 85%.

“It is hugely frustrating that the future is so horribly unpredictable. But there is a solution: simply diversify. For example, whatever happens with Brexit, it will likely not be the biggest factor affecting the companies you own in the USA, Japan or Brazil. We don’t know if the Brexit basket is going to get dropped, and we don’t know if the eggs will break if it is; but we do know that not all of your eggs are in it.

"Closing this behaviour gap is one of the best ways to improve investment returns. The best response to a crisis is usually to do nothing! Advisers should always talk about how a portfolio could perform in a crisis, and ensure their clients are psychologically prepared to hold through."

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