The Behavior Gap

1. Recognize and close the behavior gap in investing

I coined the term "behavior gap" to label the gap between investor returns and investment returns, and I started drawing the sketch you see here on every whiteboard I could find.

The behavior gap refers to the difference between investment returns and investor returns, typically caused by poor timing decisions. Investors often buy high when they're excited about rising markets and sell low when they panic during downturns, resulting in underperformance compared to the investments themselves.

To close this gap:

• Recognize your emotional biases around investing
• Stick to a long-term investment plan rather than reacting to market swings
• Avoid trying to time the market or chase hot investments
• Rebalance your portfolio periodically to maintain your target asset allocation

2. The perfect investment doesn't exist - focus on your goals

There is no such thing as the best investment.

No universal best investment exists because every person's financial situation, goals, and risk tolerance are unique. Instead of chasing the "next hot stock" or trying to beat the market, focus on:

• Defining your personal financial goals (e.g., retirement, education, home purchase)
• Creating a diversified portfolio aligned with those goals
• Choosing low-cost investments appropriate for your risk tolerance
• Regularly reviewing and adjusting your strategy as needed

Remember that what works for others may not be suitable for you. Avoid collecting random investments based on tips or trends, and instead build a cohesive portfolio strategy tailored to your specific needs.

3. Ignore financial advice and market forecasts from strangers

I don't believe that there is a secret to getting rich. But in the end, financial decisions aren't about getting rich. They're about getting what you want—getting happy.

Beware of financial predictions and "hot tips" from media, strangers, or even well-meaning friends and family. Most forecasts are educated guesses at best, and following them can lead to poor decisions. Instead:

• Focus on your personal financial situation and goals
• Make decisions based on your own research and understanding
• Consult with trusted financial professionals who know your specific circumstances
• Remember that no one can consistently predict market movements

Avoid acting on financial news or trying to time the market based on headlines. Your long-term financial success depends more on consistent savings, wise spending habits, and sticking to a well-thought-out plan than on finding the next big investment opportunity.

4. Align your financial decisions with your life goals and values

Financial decisions almost always are life decisions. Before you decide on your financial goals, you need to choose your life goals.

Money is a tool, not an end in itself. To make truly satisfying financial decisions:

• Clarify your core values and what brings you genuine happiness
• Define specific life goals that align with those values
• Create financial strategies that support your life goals
• Regularly reassess and adjust as your priorities evolve

Consider questions like:

• What experiences and relationships are most important to you?
• How do you define success and fulfillment?
• What kind of legacy do you want to leave?

By aligning your financial choices with your deeper aspirations, you're more likely to feel satisfied with your decisions and motivated to stick to your plans.

5. Too much information leads to anxiety and poor decisions

I'm saying turn it all off and go do something.

Information overload in financial media can lead to anxiety, confusion, and rash decisions. To maintain perspective and make better choices:

• Limit your consumption of financial news and market updates
• Focus on your long-term goals rather than short-term market movements
• Recognize that most daily financial news is noise, not actionable information
• Consider a "media fast" to reduce anxiety and gain clarity

When you do seek financial information:

• Choose reputable sources focused on education rather than sensationalism
• Look for data and analysis relevant to your specific goals and strategy
• Consult with trusted advisors who understand your personal situation

Remember that being well-informed doesn't mean constantly monitoring the markets or reacting to every piece of news. Often, the best action is to stick to your plan and ignore the noise.

6. Plans are worthless, but planning is essential

Financial plans are worthless, but the process of financial planning is vital.

Embrace flexibility in planning. While having a financial plan is important, recognize that life is unpredictable and your plan will need frequent adjustments. The real value lies in the ongoing process of planning:

• Set broad financial goals but be prepared to adapt them
• Make educated guesses about the future, but don't treat them as certainties
• Focus on short-term actions (next 1-3 years) that move you toward your long-term vision
• Regularly review and update your plan as circumstances change

Think of financial planning like navigating a ship:

• Set a general course toward your destination
• Make frequent small course corrections based on current conditions
• Be prepared to change your route entirely if unexpected obstacles arise

The goal is to stay flexible and responsive while keeping your ultimate objectives in mind.

7. Understand and manage your emotions around money

Investment decisions should be made based on what we know, not how we feel.

Emotions significantly impact financial decisions, often leading to poor choices. To make more rational decisions:

• Recognize common emotional triggers in financial situations (fear, greed, anxiety)
• Practice self-awareness to identify when emotions are influencing your choices
• Develop strategies to manage emotional reactions (e.g., waiting periods before major decisions)
• Focus on facts and data rather than gut feelings or market sentiment

When faced with a financial decision:

• Ask yourself if you're acting based on emotion or rational analysis
• Consider how you'd advise a friend in the same situation
• Consult with a trusted advisor or partner for an outside perspective

By understanding and managing your emotional responses, you can make more balanced and effective financial choices.

8. Take responsibility for your financial behavior

We are going to continue to run away from stocks when they cause us pain.

Own your financial choices. While external factors influence your financial situation, ultimately, your behavior determines your outcomes. To improve your financial health:

• Acknowledge past mistakes and learn from them
• Focus on factors within your control (spending, saving, education) rather than external events
• Avoid blaming others or circumstances for your financial situation
• Take proactive steps to improve your financial knowledge and skills

Practical steps to take responsibility:

• Track your spending and identify areas for improvement
• Set specific, measurable financial goals
• Educate yourself about personal finance through books, courses, or workshops
• Seek professional advice when needed, but make your own informed decisions

Remember that taking responsibility empowers you to make positive changes and improve your financial future.

9. Have meaningful conversations about money

I believe one of the most important things I can do when faced with a financial decision is to talk to someone I trust: a friend, a family member, or a paid professional.

Open communication about finances is crucial for healthy relationships and sound decision-making. To improve financial discussions:

• Create a safe, non-judgmental space to talk about money
• Listen actively to understand others' perspectives and experiences
• Be honest about your own fears, goals, and financial history
• Focus on finding solutions rather than assigning blame

Key topics for financial conversations:

• Short-term and long-term financial goals
• Attitudes toward spending, saving, and risk
• Past money experiences and their influence on current behavior
• Shared financial responsibilities and decision-making processes

Regular, open discussions about money can strengthen relationships, reduce stress, and lead to better financial outcomes for everyone involved.

10. Simplify your approach to personal finance

Think of each investment that you own as a thread in a tapestry. Each component of a portfolio should be there for a reason—and not because you think it's a candidate for world's best investment.

Simplicity in finance often leads to better outcomes. To streamline your approach:

• Focus on fundamental principles rather than complex strategies
• Choose a few well-understood investments rather than a collection of "hot" picks
• Automate savings and bill payments to reduce decision fatigue
• Regularly review and simplify your financial accounts and strategies

Steps to simplify:

• Consolidate multiple accounts (e.g., old 401(k)s, savings accounts)
• Choose broad-based index funds for core investments
• Create a simple budget focused on your most important expenses and goals
• Limit the number of credit cards and other financial products you use

Remember that a straightforward, consistent approach is often more effective than constantly chasing complex strategies or the latest financial trends.

Last updated: December 5, 2024