A few days ago I read a post by a user who claimed that he wanted to sell an ETF because it had "returned little" in the last period. The index replicated by the ETF was marking about +10% YTD, so intrigued I asked what he really meant by "low."
After a few exchanges he explained to me that he had traded the ETF several times and that, in his portfolio, the instrument was at +1.83% YTD.
Behavior gap!
I was bloody suffering from it too.
My Second Life as an Investor
My second version of being an investor (the first bought active funds at the bank) involved a highly discretionary approach to the market with 100 percent of the portfolio devoted to stock picking. I would spend several hours developing thoughts and ideas about the growth prospects of stocks, reading news to retrieve information that was actually in the public domain, if not already obsolete.
I was making money and I was happy. But my portfolio was growing because the market was growing. I was no better than average. In fact, I was below, way below.
I realized this in an afternoon I spent entering all my transactions on a tracking site. I finally discovered that I was making about a quarter of what he had made . $IWDA (+0.2%) . A little more than half of a 60/40. I think that day was the beginning of the path to the third version of me: conscious investor.
Why It Happens
The behavior gap is the difference between the theoretical return on an investment and the return the investor actually gets because of his or her behavioral decisions. Basically, it is what it costs us to be emotional humans.
It arises from a deadly combination of cognitive and emotional bias. Overconfidence convinces us that we can beat the market, market timing deludes us into thinking we can buy at lows and sell at highs. Fear of losses drives us to sell at the wrong times, while FOMO makes us buy when everything goes up.
The Challenge Continues...
After the discussion a few days ago I again challenged $IWDA (+0.2%) And again I lost. Less, very very less: -5.1% in three years against the king of benchmarks.
Those who follow me know that among the mistakes I carry in my backpack is also a very strong distribution component that penalizes me in the compounding effect and for the delay in reinvestment. But also the small Value tilt I have undertaken has reduced volatility and return.
I have improved markedly, but he, behavior gap, is still there. And I believe that as a human being I can never completely defeat him.
How I Limited the Damage
I have automated investments with PACs regular, reducing market timing temptations. I wrote an IPS, a written investment strategy, to be reviewed only once a year to limit impulsive decisions.
The behavior gap is not won, it is managed. And recognizing it is already half the battle.
