Your investing behavior matters. It matters because making some of the classic behavioral mistakes has cost average investors close to 7% per year—over half of their potential earnings.

If you purchased the average stock mutual fund in 1984, held on to it for 20 years, and didn’t do a thing, you would have earned 10.7% per year. All you had to do to get that number was buy the average mutual fund and hold on to it!

For example, if you’d invested $10,000 in 1984 in an average fund, and did nothing—neither adding money nor taking it out—your account would’ve been worth $76,375 in 2004. However, the average investor experienced the following.

Remember the 10.7% return of the average investment? Well, compare that to this number: 3.7%. The average investor’s real-life return was 3.7% during that same 20-year period.

That’s not a typo—the average investor only earned 3.7%.

Now take a minute and think about this—that’s a gap of 7% per year! This gap means that if the average investor started with a $10,000 investment in 1984, it would only be worth $20,681 after 20 years. That’s money—over $55,000—just left laying on the table. How’d this happen?

I call this the Behavior Gap, and it’s time to close it.

Before we get started, it’s critical that we all understand one issue: INVESTMENT returns and INVESTOR returns are always different.

During the last few years, you may have noticed that your returns fell short of the returns you kept reading and hearing about in the media. If so, you’re not alone. A fund’s reported return is only part of the picture. The other half, well, it’s not always pretty, and you rarely, if ever, hear it mentioned. Driven by investor behavior, the investor rate of return doesn’t always match a portfolio’s gains or losses.

Let me explain.

Your potential to earn the fund’s published return rate is based on two criteria:

  1. You bought AND held the fund for the entire time.
  2. You didn’t add or withdraw any money.

Sounds easy, right? The reality? Few people invest this way. Instead, investors chase past performance, buying funds too late (after they’ve already peaked) or selling funds too early (before they turn around).

The Behavior Gap on a Massive Scale

Let’s go on a journey back in time. As you travel with me, try to be honest about what you were seeing, thinking, and doing at the time.

By 1999, playing the stock market had become America’s favorite pastime. Now, it’s the year 2000. The stock market has gained 86% during the last three years. Remember the concept of chasing past performance? Well, it’s about to happen again. Prior to January 2000, the record for net inflows (money going in, minus money going out) into stock mutual funds was $29 billion. Now here we are in January 2000, right after an 86% run up, and look at these numbers.

In January, net inflows shot up to $44.5 billion. In February, the shortest month of the year, inflows hit $55.6 billion. That’s almost $2 billion a day! March was nothing to sneeze at either with an investment of another $39.9 billion.

Think about that. In three months, $140 billion dollars entered the market—AFTER it already had gained 86%. At a time when investors should have shown some caution, they allowed themselves to get swept along with the crowd. They allowed external factors to influence their investing behavior.

Investors paid for their irrational exuberance. March 24, 2000, marked the peak of this cycle. By October 10, 2002, the market had lost 50% of its value.

So now fast forward to 2002. After buying into the excitement of early 2000, investors had enough by October. With the stock market down over 50%, people continued to sell. October marked the fifth month in a row that investors pulled more money out of stock mutual funds than they invested. That had never happened before. I repeat, never. At the market low, instead of buying equities at the best “sale” prices in five years, investors moved their money into bond funds, making the classic mistake of having bought high and sold low. Bond funds experienced a record inflow of $140 billion in 2002. At the time, bond funders were—wait for it—at a 46-year HIGH. See a pattern?

A Behavior Gap Example

In March 2007, the Janus Enterprise Fund published its 10-year rate of return, a healthy 9.44%. Now, remember, the investment rate of return assumes you invested a set amount of money in the beginning and left it alone—no adding or subtracting. What about the average investor return? That number was different. The average Janus Fund investor saw a return rate of -10.13%. That’s not a typo. -10.13%. That’s a gap of 19.6%.

The Janus investor rate of return is an extreme example of bad behavior. Your gap experience may not be that big. However, regardless of size, the same types of behavior create the gap between the investment and investor rate of return. To begin closing the gap, you need to understand what behavior creates it.

The Common Behavioral Mistakes

We know it doesn’t make sense to buy high and sell low. We’ve known that since we were kids. But we all do it, and we do it over, and over, and over. It’s time to change the way you invest, and it has very little to do with finding the perfect investment—it’s all about changing your behavior.

1. Confusing Speculating with Investing

Good behavior closely mirrors the patience shown in planting an oak tree. Over time, the tree will grow and spread its roots deep, only reaching its full size after many years. The oak tree wouldn’t reach its potential if you replanted it in a new spot every year, hoping to get better growth. This speculative behavior focuses on short-term results and shows no patience for day-to-day fluctuations, costing you in the long run. On the other hand, behavior that focuses on investing in long-term goals will pay off handsomely in the future.

2.  Confusing Investing with Entertainment

Investors have a bad habit of treating the stock market like a Monopoly® game.

You’ll do yourself, and your investments a favor if you go to the movies instead. When you try to make investing entertaining, you start making decisions that aren’t based on what’s best for the long term but rather on what perks up your day. We aren’t dealing with play money. This is the real thing, and you’ve worked too long and too hard to throw it away. Trust me. Go to the movies.

3.  Confusing Intelligence with Ability

You’re smart. You’re successful. Other- wise you wouldn’t have money to invest. So, shouldn’t you handle your investments? Investment success isn’t about skill. It’s about behavior. Consider this example.

When you ask people if they are better-than-average drivers, almost everyone will tell you “yes”—despite what their driving records say. The same is true for investing. Most people are overconfident in their ability to invest successfully. It stems from the tendency of human beings to think we’re smarter or more able than we are.

Now that you know the gap exists, and why it exists, the question remains, “How do you close it?”

Closing the Gap

I believe that changing investing behavior can change the world. We’re talking about the difference between you having financial freedom versus constantly watching the ticker tape run across the bottom of CNBC. If you’ve been muttering under your breath while you read it, “I knew that” or “Wait a minute…” then you it might be time to accept the reality that you’d benefit from working with a real financial advisor.

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