The Behaviour Gap: Simple Ways to Stop Doing Dumb Things with Money

We all manage our finances in different ways. Some of us speculate in stocks, some buy funds, bonds, gold, real estate, and some invest in antiques. In a nutshell, we tend to follow whatever is popular. We all want to be given some helpful advice and find that perfect investment plan! We even think that if we keep an eye on the market every day, listen to the news, use historical data and combine it with our own experience, we will be able to make the right choices and make a profit. But here's the thing: even if we do all of that, we still can't make money, and we even lose a lot. This is totally normal! We all make decisions based on our emotions, like fear and greed. We all have a tendency to fall a little short of doing what we know we should do. The author kindly refers to this gap as the "behavioural gap".

We know that lots of companies have tried to work out how investor behaviour affects actual investment returns. After lots of research, Morningstar and Dalbar found that the actual returns investors get on stock funds are much lower than the average return of the funds themselves. In other words, there's a little bit of a gap between the two, and this gap is what we call the "behavioral gap." This means that when it comes to investing in funds, we can actually make more money just by putting money into an ordinary stock fund and doing nothing! But most investors give up this money that is within reach. They keep moving money in and out of stock funds, and they often don't have the best sense of when to make changes – which unfortunately leads to them losing a lot of money. So, the author thinks that investing is really just a choice that people make, and that choice can be affected by our emotions. The good news is that you can make investing more effective by making your own decisions.

The lovely Carl Richards is the author of this book. He's a certified financial planner in Park City, Utah, and the founder of a portfolio design company. He often writes for the New York Times and Morningstar Advisor, and he has a lovely way of using markers to scribble on tissues or other pieces of torn paper to explain complex financial issues. His views and approach are a breath of fresh air and a real joy to experience. Many people think his work is priceless! And that's how this book was born!

The book is all about two main things: how to beat those pesky emotions and how to make your financial planning fit your needs.

In the first part, we'll chat about how our emotions can affect our financial management. It's fair to say that emotions have a huge impact on how we act and what we do. We all do it! When it comes to making financial decisions, we often fall into some emotional traps. Let's explore which emotions affect us the most.

Fear and greed are two of the most common emotions we all face. We all know that we should "buy low and sell high" to make a profit, but we are only human and we are always affected by our emotions. In practice, we "chase upswings and kill downswings" and "buy high and sell low". We all know deep down that this is wrong, but somehow, every time we make a decision, we still make the same mistake. We are always so forgetful, aren't we? We all do it! We keep repeating this behaviour until we eventually go bankrupt or pay a heavy price. Let's take the US stock market crash of 2002 as an example. When the market crashed, people were understandably afraid and withdrew their investments. Then, when the market bounced back in 2004, people were so excited to invest that they went a bit crazy! Some even mortgaged their homes to invest in stocks.

The author often has this kind of chat with his lovely clients:

In 2009, the stock market crashed, and three of the author's clients unfortunately suffered heavy losses. They came to the author and said,

Client: Hey Karl, we think it might be a good idea to sell.

Author: So you're saying we should sell a stock just because its value has fallen by 30%? I can understand why you'd think that, but I'm not sure that's the right move.

Client: Well, you know, should we just sit back and watch it keep falling?

Author: Oh dear, it's already too late. I know you might be thinking about selling, but is now really the right time?

Client: We're feeling a little nervous, to be honest!

Author: It's totally normal to feel scared, but it's not a good idea to let it stop you from taking action.

Client: Oh, this is just so painful! Oh dear, if the stock keeps on falling like this, we'll be left with nothing by the end of the year.

Author: I totally get it. Stocks were actually more risky when they were at a high price than they are now. But at that time, you were all happy to hold on to them, so why sell now? I totally get it!

Hello, my client! So, what do you think we should do?

Author: I know it's a tough call, but my advice would be to do nothing for now. Wait until you feel a bit calmer, then take a look at your investment plan and see if you need to make any adjustments.

This kind of conversation is pretty common, and even the author himself gets swept up in the emotions sometimes! The author lives in lovely Park City, where skiing is a huge pastime. So he bought four pairs of skis, each one perfect for a different kind of snowy adventure! One time, a friend asked him to go skiing, so he ran to the garage, stared at the four pairs of skis, and was at a loss. When it was time to go, he was still undecided about which pair to choose. After being encouraged by his friend, the author finally chose the pair he liked best. They were light, fast and perfect for cross-country skiing! This experience really stuck with the author. He'd put so much time, energy and money into collecting the four pairs of skis, just so he'd have the right equipment for every situation. But when it came to actually choosing, the skis made him feel a bit powerless.

So he made the decision to get rid of the other three pairs and keep only the ones he liked best. While these skis might not be the perfect choice for every type of piste, they perform really well on most and are absolutely fantastic on the author's favourite type of piste! The author is so happy now that he doesn't have to worry about which skis to take. He just picks them up and goes! Even if he does happen to come across a piste that these skis aren't suited to, the author is pretty confident that with his experience, adaptability and a little bit of luck, there'll be no major problems.

It's so interesting how your mood can influence the decisions you make, isn't it? This is something that actually happens a lot in the world of finance. Many of us think that making good financial decisions means being absolutely sure and taking every possibility into account. It's so important to think about every possible risk and to invest in all the markets. It's so important to keep on top of what's going on in the markets and to try to get it right. That way, you can feel confident and never be defeated. It's so important to keep up with everything that's going on in the financial markets. And it's also a great idea to tighten your belt a little and save as much as you can.

These thoughts actually come from a place of fear, which is totally understandable! We all have an instinctive fear of the uncertainty of life and its ups and downs. That's why we make all kinds of plans, hoping that we can master our future through them. We all think that if we do this, then that won't happen. We even think that if we sell our shares now, we can avoid the market crash! And we all want to believe that if we invest with pinpoint accuracy, our financial security will be guaranteed. But the truth is, if we have worried about everything, we can face the real bad news when it comes.

The thing is, the real world is pretty complicated, and it's just not possible to predict what the future will bring. This means that most of our plans are useless, but that's ok! And it's so easy to confuse greed and fear! They're often seen as motivators, but they're actually the same thing. It's so easy to get caught up in our greed, isn't it? We often forget that it stems from fear. Both of these things influence our actions and cause us to waste our lives and money on things that are not important at all.

The wonderful Dr. Rachel Naomi Remen, who started the American spiritual-physical wellness movement, thinks that economic crises are great chances for us all to think about our spirituality. She thinks that our financial choices often show where we're feeling a bit lost or unsure. If you're feeling a bit uneasy, it's only natural to look for ways to feel safer and to feel like you belong to a group. This might mean buying the same car and clothes as your neighbours or taking expensive holidays like they do. But, my friend, this will not reduce your sense of isolation. We might be making some financial sacrifices without even realising it, in our quest for emotional security.

The first emotion to catch us off guard is fear. The second emotion that affects us is overconfidence. We all make mistakes! We can't predict the future, and we're not as clever as we think we are, are we? It's often the case that the higher the level of overconfidence, the higher the cost of a mistake.

The folks running the American hedge fund Long-Term Capital Management were pretty sharp, with a few of them even winning the Nobel Prize! They were once absolutely certain that their investment choices would never lose more than 35 million dollars in a single day – bless them! But then, one day in 1998, they lost 553 million dollars, and the company ended up losing a total of 3 billion dollars.

Alan Greenspan, who served as chairman of the Federal Reserve four times, was always thought of as someone who was always right. However, the economic model that Mr. Greenspan had firmly believed in for nearly 40 years sadly led to the worst market disaster in the United States since the Great Depression of the 1930s. Later on, he even told the US Congress that when he realised that the economic model he'd always had so much confidence in was actually flawed, he completely broke down. Even these clever people are prone to the error of overconfidence. It's something that can happen to anyone, even us ordinary folks!

And, of course, there's another emotion that we all experience from time to time: gullibility. We all look for that one guru who can predict the economic outlook so we can get ready in advance, but that's not how it works. We don't know what the future holds, and that's okay! It's so tricky trying to predict what's going to happen in the future! History doesn't always give us the answers we're looking for. As it turns out, it's really quite tricky to predict the future correctly! Even if someone guesses right about a market change, it's only a matter of probability, so it's probably best not to get too excited about it. It's so important to remember that nobody can predict the future! It's important to remember that the advice you get from your relatives, friends, and even experts and scholars might not be right for you. It's always good to think about why they're giving you that advice and whether it's something you can apply to your own situation.

The author has had a bit of a tough time himself. In 1999, technology stocks were all the rage! So many people were eager to get in on the action and even mortgaged their houses to speculate in stocks. The author's brother-in-law worked for a high-tech company and he often told the author how amazingly promising the development of technology was and how much room there would be for the stocks of these technology companies to rise. At first, the author was really trying to hold back from buying, and with the encouragement of his loved ones, he also resisted the urge to join in. In the end, he just couldn't help himself and invested a large sum of money in what he thought was a very good technology stock. And wouldn't you know it, the stock did indeed rise from 100 US dollars to 1,300 US dollars! But what he hadn't counted on was that by March 2001, the stock had fallen below 25 US dollars, and the poor author had suffered some pretty heavy losses. Afterwards, the author put the stock up on the wall as a little reminder to himself to make sure he didn't make the same mistake again! He came to the conclusion that when even the most rational and patient of investors join a market, it's probably the market's peak and it's time to be extra vigilant.

Back in July 2010, the well-known market forecaster Robert Precht made an interesting prediction: "I'm sorry to say that a bull market is coming to an end, which means the Dow Jones Industrial Average will fall from the current 9686.48 points to below 1000 points in the next five or six years." In early 2011, Yale University's Robert Shiller made an interesting prediction. He said that the S&P 500 index would rise from 1,280 to 1,430 over the next 10 years. That's an average annual increase of 1.3%. In January 2011, Laszlo Birinyi, who has many years of experience in the market, made a prediction that the S&P index would close at 2,854 on 4 September 2013. It's so interesting how three market prophets, almost at the same time, published three very different and extreme predictions in highly credible mainstream media! As investors, it can be really tough to know who to believe! What should we do, then? The author kindly suggests that we ignore them!

Let's take a moment to look at these emotional pitfalls. I'm sure we've all been there! It's so easy to get caught up in fear, overconfidence and gullibility. They can really affect our rational judgement! It's these emotions that can cause a bit of a "behavioral gap" in our decision-making, which can unfortunately lead to some unnecessary losses. So, it's really important to try to avoid letting our emotions influence our investment and financial decisions.

Part 2

The following part is all about how we can make our financial decisions our own, and fit them to our own needs. Firstly, make financial management simple and avoid getting caught up in your emotions. It's so important to remember why we're all concerned about financial security. We all want to be happy and provide a good life for those we love. I think it's safe to say that almost all financial decisions are really just life choices. Your financial goals might be to retire comfortably, send your kids to college, educate them, travel, and so on. So, there's no need to spend ages looking for the perfect financial product. Instead, think about what's really important to you and then adjust the way you use your money according to these values.

Let me tell you a story. It's about a financial expert who had been following the markets for over 30 years. One winter's evening in 2011, he was having a drink with his friend Gerti in a bar. Gerti was a seasoned veteran of the electronics industry. At the time, there was a TV in the bar showing a programme in which a government spokesman was chatting about the price of oil. He said that the price of oil had gone up because of the chaos in Libya. When she heard this, Gerti said to the financial expert, "Oh, that guy is such a goofball!" "Libya?" "Oh, I don't think that's the reason. We don't import much oil from Libya, so I'm sure there's another reason." The financial advisor thinks about it for a moment and agrees with Gritti, saying, "I think you're right." "Even though Libya is a net exporter of crude oil, it only ranks 17th in the world in terms of crude oil reserves and doesn't have any direct trade exports with the United States.

So it seems a bit much to be worried that Libya will stop exporting oil, don't you think? But you know, a tiny little detail like this could set off a huge event, based entirely on greed or fear. It could happen in the blink of an eye and send us hurtling into a bigger financial crisis.

It's impossible to plan for every eventuality, and that's a good thing! You don't have to choose the perfect investment, save a lot of money, guess the return on investment, sit in front of the TV all day watching stock market analyses or go online and frantically search for stock picking secrets.

There's no need to stress! There's no need to worry about having a perfect plan that takes every eventuality into account. It's so important to make your financial decisions in line with your outlook on life and the world. The more you know yourself, the better your chances of success with your investments. This means that your investments will be more in line with your real-life goals, which is great! It's so important to make choices carefully based on the actual situation. That's the best way to help us achieve our goals!

It's so important to remember that things change so quickly, and we can't predict the future. So when we have a long-term plan, it's a great idea to shift our focus to what we can do in the short term, say three years, to help us pay more attention to what is happening now. It's so important to live in the present moment! That way, we can be really aware of what's going on around us and then act in a way that's true to who we are. I'm sure you'll agree that acting on a realistic financial plan usually leads to better results! It's so important to keep the planning process going – it's not the plan itself that matters – so you can keep moving towards your goals and avoid any pitfalls along the way.

It's always good to remember that when it comes to investments, if there's a big potential return, there's usually a big risk too. So, it's not a good idea to focus all your attention on trying to get the highest returns possible. Even if you make the smartest decisions you can, there's no way to control the outcome. We often grumble about this, but it doesn't help. We also do things that aren't actually cost-effective in order to save money. So, when you're making decisions, it's really important to make sure you're not just focusing on making money. It's also really helpful to think about your understanding of morality, wisdom and common sense. We all have to take responsibility for our own actions, but we can't control what happens next.

So, the first way to avoid getting caught up in your emotions is to figure out what you truly want and then make a choice that's right for you, based on the situation at hand. Don't get caught up in chasing high profits blindly — that's not the best way to go about it! The second way is to remember that not everyone has your best interests at heart. It's always a good idea to avoid falling into the trap of vague financial advice! It's so important to remember that personal finance is a personal matter. It's not about financial management, it's about you! So, the best way to plan your finances is to do it on a personal basis.

There's no such thing as the "best" investment, but that's okay! We all have different situations and different investment options, and that's totally okay! Let me give you an example. Some people are looking for a hot stock, but they haven't yet got life insurance or disability insurance. And some people are on the hunt for a deposit account with the highest interest rate, but they've got an unpaid credit card in their pocket with an interest rate of up to 18%. Oh dear, this is a little strange. Why not use the deposit to pay off part of the credit card bill first? That would be a great idea! That's right! It's like getting an 18% interest return!

It might be a good idea to think of work as a way of making money and investment as a way of protecting your wealth. It's so important to remember that you can't control the market, but you can control what you do. So, focus on your personal finances and don't worry about global economic changes. We can make a real difference to our financial situation by working hard, saving more or earning more.

One of the author's dear friends has been struggling with depression since his 20s. He later took out a mortgage on his house and used the loan to see a psychiatrist. Five years later, he was feeling well enough to quit his job, which he felt had no future, and start writing. Guess what! He has now sold more than 500,000 copies of his books and has published countless articles. He says that seeing a psychiatrist was the best financial decision he ever made!

The most important thing for everyone to think about is how to put all the information and ideas they've gathered into practice in their own lives. Just because something is good advice for you doesn't mean it'll be right for your neighbour. So, my advice to you is not to follow general advice from others, including that of professional advisors and financial planners. And don't believe in so-called market forecasts either! It's so important to combine your own situation with your own experience to choose an investment method that suits you.

I know it can be tempting to trust others blindly, but I promise you'll thank me for this next bit! It's so important to avoid being overconfident or acting according to habit. Instead, make dynamic adjustments according to actual changes. We can put together our own investment plan based on what we know about the current financial market trends and what we'd like to achieve in the next few years. And if things change, we can change our plan to suit! If we need to listen to other people's opinions, it's always a good idea to find someone who knows us and can be trusted – not some stranger on TV!

It's probably best not to be looking for the next Apple or Google, as the chances of you picking the next big thing are pretty slim. It's not a great idea to choose stocks based on how well they've done in the past. It's also not a great idea to judge whether the next coin toss will be heads or tails based on the result of the last toss.

It's so important to find your focus, because we only have a limited amount of time and energy, and we need to make the most of it! I've found a simple principle that really works for me: focus your attention on what's important to you and on which you can exert influence. It's so important to have a basic understanding of the investments we're making. We can't afford to follow or make decisions based on limited experience. What we really need to do is take a step back and arrange our financial future in a way that works for us. We shouldn't just be chasing the highest return on investment. We all have different ways of seeking balance, don't we?

One day, an older female client called the author out of the blue to ask for advice. She was feeling really worried about what was going on in Lebanon and wanted to know if it would affect her investments. The author reassured her with two simple facts: first, the situation in Lebanon would not have a significant impact on her life; second, no matter what she did, she couldn't influence the situation in Lebanon. There are so many examples like this in real life! It's only natural to worry about things we can't control. So, focus on what matters to you and what you can influence with your actions, and forget the rest. You've got this!

It's always a great idea to take a close look at our investment portfolio from time to time to make sure it's still on track with our goals. It's so easy to forget about risks because of inertia and familiarity. It's always a good idea to make investment decisions based on what we know, rather than on gut feeling. It's totally normal to let our emotions influence our decisions. We all do it! But we can try to make knowledge play a bigger role in our financial decisions. Investing is a bit like life, isn't it? It forces us to make decisions in the fog of uncertainty. Nobody's perfect, and that's okay! We can't always be right or wrong. The best we can do is make decisions based on the information we have. Then, we can observe the results, take into account the latest information as it emerges, adjust the course, and then keep repeating the process. Okay, this is the third method we're talking about. Don't be too sure about things or act on inertia, but be flexible and adapt to what's actually going on.

In a nutshell, that's what this book is all about! Let's go over it together, shall we? The author believes that investment decisions are often influenced by emotions. And it's not the market conditions that make investment more effective, it's our own decisions! To beat those emotions, we need to first identify what we truly want. Then, we can make choices that are right for us, rather than chasing high profits blindly. Secondly, it's really important not to believe everything you hear and to avoid getting caught up in vague financial advice. Thirdly, it's good to be confident, but don't be overconfident or act according to habit. Make dynamic adjustments according to actual changes instead. In short, the most important thing to make the right financial decisions is to invest slowly and steadily and to try to make your investments as tailored as possible to your needs.