When it comes to investing, we can be our own worst enemies. There are numerous studies showing a gap between the average returns of the markets, and the returns of investors actually investing in those markets. This harmful discrepancy is known in investing circles as the “investment behavior gap.”
Although most investors sabotage their returns because of their behaviors, it is possible to tilt the investment behavior gap in your favor.
Here are some focal points on how to bridge the investment behavior gap, and even possibly make better returns than the market averages:
One large source of the investment behavior gap is a lack of diversification. If you’re completely invested in one asset class or market, you will feel a very painful sting during a downturn; possibly leading to poor decision-making.
For instance, if you’re solely invested in the S&P 500, you’ll feel an enormous temptation to sell when that market is down and all of your wealth is subsequently losing value. This would lead you to sell at a low, while the market itself is likely to eventually recover and reach new highs.
Diversifying your capital can greatly reduce that burning desire to make knee-jerk reactions, because not all of your wealth will be tied into a downturn. When international stocks are down, for instance, domestic stocks might be up, and vice versa.
Outline a clear investment strategy and goals
Another source behind the investment behavior gap is the tendency of investors to make decisions that misalign with their actual goals. Our brains are wired to focus on the short-term. While that may have served well for evolutionary purposes, it can be devastating for most investors.
When your investing behavior is based on short-term results, you’re often inadvertently disrupting your long-term goals. Trying to time the market, for instance, might seem like a smart decision in the moment, but it doesn’t work well for the average investor.
A well-laid out investment strategy with clear goals (like how much you want to save for retirement) is the best defense. That way, you can avoid myopia by having concrete objectives on the horizon. Even better, if you’re working with an advisor, you can utilize an Investment Policy Statement.
Avoid the herd mentality
What the studies on the investment behavior gap indicate is that following the crowd will lead to the opposite of successful investing behavior. These statistics show that following what others are doing often leads to selling low and buying high. Avoiding the herd mentality (whether it’s advice from an “expert” on TV or just following market trends) is critical for closing the investment behavior gap.
Learn more on how to beat the investment behavior gap
At LexION Capital, we strictly make investment decisions based on the math and science of the markets to help our clients meet their financial needs and goals. If you’d like to learn more about how we can help you beat the investment behavior gap, let’s have a conversation.