The Behavior Gap
by Alex Ng
Carl Richards’ insights into closing the behavior gap that separates investment returns from investor returns.
The Big Idea
"The biggest threat to your investment returns isn't the market - it's your own behavior. The 'behavior gap' is the difference between investment returns and investor returns, caused by buying high when excited and selling low when scared."
Key Insights
The Behavior Gap
Studies show that investors earn significantly less than the funds they invest in. This isn't because of fees or fund selection - it's because investors buy after funds go up (fear of missing out) and sell after funds go down (fear of more losses).
From 1984-2002, the S&P 500 averaged 12.2% annually. The average investor earned only 2.6%. The difference - the behavior gap - came from poor timing driven by emotion.
We're Wired Wrong for Investing
Our brains evolved to keep us safe on the savannah, not to invest wisely. Fear and greed - useful for avoiding predators and finding food - lead us to exactly wrong decisions in financial markets.
When markets crash, your brain screams 'danger!' and demands you sell. When markets soar, it says 'opportunity!' and demands you buy more. In both cases, it's wrong.
Simplicity Beats Complexity
The financial industry sells complexity because it justifies fees. But simple strategies consistently outperform complex ones. A diversified portfolio of low-cost index funds, held through thick and thin, beats almost everything.
Richards advocates for simple portfolios that can be drawn on a napkin. If you can't explain your investment strategy in a few sentences, it's probably too complex.
Know Your 'Enough'
Without knowing what 'enough' means to you, you're running a race with no finish line. Define what you actually need - not what you think you want - and align your investments with those goals.
Many investors chase returns without knowing why. Ask yourself: What do you need money for? When? How much? Your investment strategy should flow from these answers.
Chapter Breakdown
The Problem: We're Our Own Worst Enemy
The behavior gap is the difference between investment returns and investor returns. It's caused by our tendency to buy when we're excited (after markets rise) and sell when we're scared (after markets fall). This pattern ensures we buy high and sell low - the exact opposite of what works.
Why We Make These Mistakes
Our brains evolved for survival, not investing. The same instincts that kept our ancestors alive lead us astray in financial markets. Fear says sell; greed says buy more. Both feelings intensify at exactly the wrong times.
Financial media amplifies the problem by creating urgency and fear. Headlines that generate clicks rarely generate good investment decisions.
The Solution: Simple Rules, Followed Consistently
Richards advocates for simple portfolios - diversified, low-cost index funds held for the long term. The key isn't finding the perfect allocation; it's sticking with a good-enough allocation through market cycles.
Create an investment policy statement when you're calm. Define what you'll do in various scenarios. Then follow it when emotions run high.
Know Your Enough
Before investing, know what you're investing for. What do you need money for? When? How much? These questions should drive your strategy, not the pursuit of maximum returns.
Many people take more risk than necessary because they haven't defined 'enough.' If your goals require 5% returns, why chase 10% with additional risk?
Getting Help
A good financial advisor's main value isn't picking investments - it's helping you avoid behavior gap mistakes. Having someone to talk you off the ledge during market panics may be worth their fee.
Take Action
Practical steps you can implement today:
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Before making any investment change, wait 24 hours. Emotional decisions rarely improve outcomes
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Write down your investment strategy and rules when you're calm. Commit to following them when you're not
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Calculate how much you actually need for your goals - you may be taking unnecessary risk chasing returns you don't need
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Simplify your portfolio to something you can explain on a napkin - complexity doesn't improve returns
Summary Written By
Software Engineer & Writer
Software engineer with a passion for distilling complex ideas into actionable insights. Writes about finance, investment, entrepreneurship, and technology.
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