1 00:00:00,680 --> 00:00:03,600 Speaker 1: In misbehaving saving me? 2 00:00:05,880 --> 00:00:09,480 Speaker 2: How many times has this happened to you? Some interesting 3 00:00:09,560 --> 00:00:13,560 Speaker 2: new fund manager or ETF is putting up great numbers, 4 00:00:13,680 --> 00:00:17,440 Speaker 2: sometimes for years, and you take the plunge and finally 5 00:00:17,480 --> 00:00:21,279 Speaker 2: buy it. It's a hot fund with tremendous performance. But 6 00:00:21,440 --> 00:00:25,079 Speaker 2: after a few years you review your portfolio and wonder, hey, 7 00:00:25,160 --> 00:00:28,080 Speaker 2: how come my returns aren't nearly as good as expected. 8 00:00:28,920 --> 00:00:32,720 Speaker 2: You may be experiencing what has become known as the 9 00:00:32,760 --> 00:00:37,600 Speaker 2: behavior gap. It's the reason your actual performance is much 10 00:00:37,640 --> 00:00:41,800 Speaker 2: worse than the fund you purchase. I'm Barry Riddolts, and 11 00:00:41,840 --> 00:00:44,960 Speaker 2: on today's edition of At the Money, we're going to 12 00:00:45,000 --> 00:00:48,960 Speaker 2: discuss how to avoid suffering from the behavior gap. To 13 00:00:49,040 --> 00:00:51,160 Speaker 2: help us unpack all of this and what it means 14 00:00:51,159 --> 00:00:55,320 Speaker 2: for your portfolio, let's bring in Carl Richards. He's the 15 00:00:55,400 --> 00:00:59,720 Speaker 2: author of The Behavior Gap, Simple Ways to Stop Doing 16 00:01:00,240 --> 00:01:04,800 Speaker 2: Things with Money. The book focuses on the underlying behavioral 17 00:01:04,880 --> 00:01:10,279 Speaker 2: issues that lead people to make poor financial decisions. So Carl, 18 00:01:10,480 --> 00:01:14,640 Speaker 2: let's just start with a basic definition. What is the 19 00:01:14,680 --> 00:01:15,560 Speaker 2: behavior gap? 20 00:01:15,840 --> 00:01:18,119 Speaker 1: Thanks? Verry, super fun to chat with you about this. 21 00:01:18,160 --> 00:01:21,840 Speaker 1: So I this is going back now twenty years right, 22 00:01:22,080 --> 00:01:24,920 Speaker 1: like I just stumbled upon this early on in my 23 00:01:25,000 --> 00:01:28,720 Speaker 1: work with investors that we would get all excited. I 24 00:01:28,760 --> 00:01:31,559 Speaker 1: would get all excited as you, exactly as you said, 25 00:01:31,600 --> 00:01:34,440 Speaker 1: like we would do some performance review. We would find 26 00:01:34,440 --> 00:01:37,080 Speaker 1: some fund we thought was great. Of course, past performance 27 00:01:37,120 --> 00:01:39,199 Speaker 1: is no indication of future results. But what's the first 28 00:01:39,200 --> 00:01:42,320 Speaker 1: thing you look at when you decide to make Yeah, 29 00:01:42,400 --> 00:01:45,240 Speaker 1: past performance, get all excited about it, and then you 30 00:01:45,280 --> 00:01:48,040 Speaker 1: have this inevitable letdown. And so I think the easiest 31 00:01:48,040 --> 00:01:50,800 Speaker 1: way to describe this is imagine you open the newspaper 32 00:01:51,640 --> 00:01:56,560 Speaker 1: and there's an there's an advertisement, Remember the old fashioned newspaper, right, 33 00:01:56,600 --> 00:01:58,920 Speaker 1: There's an advertisement for a mutual fund that says ten 34 00:01:59,040 --> 00:02:03,360 Speaker 1: year average annual return of ten percent. Well, that's the 35 00:02:03,440 --> 00:02:07,440 Speaker 1: investment return. And I think we all forget that investments 36 00:02:07,520 --> 00:02:11,480 Speaker 1: are different than investors, and so the behavior gap is 37 00:02:11,520 --> 00:02:14,960 Speaker 1: the difference between the investment return and the return you 38 00:02:16,120 --> 00:02:20,120 Speaker 1: earn as an investor in your account. And my experience 39 00:02:21,200 --> 00:02:26,520 Speaker 1: and the data show that often individual investors underperform the 40 00:02:26,600 --> 00:02:31,880 Speaker 1: average investment. So it's this well intentioned behavior of finding 41 00:02:31,960 --> 00:02:36,640 Speaker 1: the best investment is generating a suboptimal result for us 42 00:02:36,680 --> 00:02:37,440 Speaker 1: as investors. 43 00:02:37,840 --> 00:02:40,200 Speaker 2: So what's the underlying basis for that? 44 00:02:40,360 --> 00:02:40,640 Speaker 1: Gap. 45 00:02:40,720 --> 00:02:44,320 Speaker 2: I'm assuming, especially if we're talking about a hot fund, 46 00:02:45,280 --> 00:02:48,640 Speaker 2: the fund has had a great run up, people buy, 47 00:02:49,280 --> 00:02:52,320 Speaker 2: if not the top, well certainly after it's had a 48 00:02:52,320 --> 00:02:55,000 Speaker 2: big move, and then a little bit of mean reversion 49 00:02:55,080 --> 00:02:58,000 Speaker 2: comes back into it. The fund does poorly for a 50 00:02:58,000 --> 00:02:59,920 Speaker 2: couple of years and then kind of goes back to 51 00:03:00,080 --> 00:03:04,079 Speaker 2: where it was. Is just as simple as buying high 52 00:03:04,200 --> 00:03:07,240 Speaker 2: and being stuck with it low? Is it that simple? 53 00:03:07,560 --> 00:03:09,800 Speaker 1: Yeah, it's interesting. Let me just tell you a quick story, 54 00:03:09,800 --> 00:03:13,040 Speaker 1: and this is about all great investment stories are about 55 00:03:13,040 --> 00:03:15,240 Speaker 1: your father in law. Right, So I remember my father 56 00:03:15,240 --> 00:03:18,960 Speaker 1: in law in ninety seven, ninety eight, ninety nine, he 57 00:03:19,000 --> 00:03:22,799 Speaker 1: had an investment advisors was named Carter. I remember all this, 58 00:03:23,600 --> 00:03:26,640 Speaker 1: and he owned and I can name specific funds because 59 00:03:26,680 --> 00:03:30,120 Speaker 1: these things are not the problem. The fund didn't make 60 00:03:30,160 --> 00:03:34,280 Speaker 1: the mistake, right, So Alliance Premier Growth, if you remember 61 00:03:34,400 --> 00:03:37,520 Speaker 1: ninety seven, ninety eight, ninety nine, just you know he 62 00:03:37,520 --> 00:03:41,000 Speaker 1: owned Alliance Premier Growth, and he owned Davis New York Venture, 63 00:03:41,080 --> 00:03:44,680 Speaker 1: so a go go growth fund and something that was 64 00:03:44,760 --> 00:03:48,720 Speaker 1: classically value. And at the end of ninety seven he 65 00:03:48,760 --> 00:03:50,280 Speaker 1: looks at his returns and he's like, why do we 66 00:03:50,320 --> 00:03:53,120 Speaker 1: own this? This Davis this value fund. Why do we 67 00:03:53,160 --> 00:03:57,200 Speaker 1: own this thing? Carter talks him into rebalancing, which means 68 00:03:57,200 --> 00:04:00,760 Speaker 1: he took some from Alliance Premier Growth it to Davis, 69 00:04:00,800 --> 00:04:04,119 Speaker 1: opposite of what he felt like doing. Right. Ninety eight 70 00:04:04,120 --> 00:04:07,600 Speaker 1: comes wrong, same thing, Alliance Premier Growth knocks it out 71 00:04:07,600 --> 00:04:12,000 Speaker 1: of the park. Davis only does like twelve percent or something, right, 72 00:04:13,040 --> 00:04:16,400 Speaker 1: father in law complains. Carter says, hey, please come on, like, 73 00:04:16,520 --> 00:04:18,760 Speaker 1: this is just this is just what we do. We're 74 00:04:18,760 --> 00:04:20,560 Speaker 1: actually going to do the opposite of what you feel. 75 00:04:20,720 --> 00:04:23,400 Speaker 1: We're going to sell some Alliance Premier Growth. We're going 76 00:04:23,440 --> 00:04:27,640 Speaker 1: to rebalance into Davis ninety nine, right, And I can't 77 00:04:27,680 --> 00:04:30,680 Speaker 1: call the exact numbers, but if I Alliance did something 78 00:04:30,760 --> 00:04:36,600 Speaker 1: like fifty four percent and Davis only did seventeen, and 79 00:04:36,640 --> 00:04:39,040 Speaker 1: my father in law was like, that's it, that's it. 80 00:04:39,080 --> 00:04:41,960 Speaker 1: And I remember New Year, like over Christmas, over the 81 00:04:42,040 --> 00:04:45,919 Speaker 1: Christmas holiday of ninety nine, right, and you know what 82 00:04:45,960 --> 00:04:48,880 Speaker 1: happens next, he tells me, He's like, yeah, I finally 83 00:04:48,920 --> 00:04:51,200 Speaker 1: had enough. I fired those Davis, that Davis New York 84 00:04:51,240 --> 00:04:53,360 Speaker 1: Venture Fund and moved all the money to Alliance Premier 85 00:04:53,400 --> 00:04:55,919 Speaker 1: Growth just in time. You know, we had another He 86 00:04:55,960 --> 00:04:59,839 Speaker 1: felt like a hero for January February and then March 87 00:04:59,880 --> 00:05:02,760 Speaker 1: of two thousand, just in time to get its head 88 00:05:02,760 --> 00:05:06,279 Speaker 1: taken off. And we repeat that over and over, and 89 00:05:06,320 --> 00:05:09,400 Speaker 1: it's kind of wired into us. So's it's challenging. You 90 00:05:09,440 --> 00:05:14,240 Speaker 1: want more of what gives you security or pleasure, and 91 00:05:14,320 --> 00:05:16,440 Speaker 1: you want to run away from things that cause you 92 00:05:16,480 --> 00:05:19,680 Speaker 1: pain as fast as possible. And somehow we've translated that 93 00:05:19,760 --> 00:05:24,280 Speaker 1: into by high and so low and repeat until broke. Huh. 94 00:05:24,560 --> 00:05:28,160 Speaker 2: And I happen to have the number one of that 95 00:05:28,279 --> 00:05:32,479 Speaker 2: series of lithographs you did, repeat until yes, hanging in 96 00:05:32,520 --> 00:05:36,640 Speaker 2: my office. And let's put a little a little meat 97 00:05:36,680 --> 00:05:41,440 Speaker 2: on the bones if you were heavily invested in any 98 00:05:41,480 --> 00:05:45,720 Speaker 2: fund that was heavily exposed to the Nasdaq from the 99 00:05:45,720 --> 00:05:48,560 Speaker 2: peak in March two thousand to just two years later. 100 00:05:48,600 --> 00:05:52,880 Speaker 2: By October of two the Nasdaq was down about eighty 101 00:05:52,920 --> 00:05:55,320 Speaker 2: one percent pete to troth. Yeah, that's a hell of 102 00:05:55,320 --> 00:05:58,200 Speaker 2: a haircut, losing four fifths of the value. 103 00:05:58,320 --> 00:06:01,520 Speaker 1: Especially just I mean, I remember those conversations like there 104 00:06:01,600 --> 00:06:03,880 Speaker 1: was I mean, this is kind of fun to poke 105 00:06:03,920 --> 00:06:07,120 Speaker 1: fun at your father in law, right, but it wasn't 106 00:06:07,200 --> 00:06:10,200 Speaker 1: very fun when there was like some pretty major drastic 107 00:06:10,279 --> 00:06:12,919 Speaker 1: changes in the way the family was operating because of 108 00:06:12,960 --> 00:06:15,240 Speaker 1: that experience, Like it was, it was a real deal 109 00:06:15,320 --> 00:06:18,960 Speaker 1: for lots of people, right sure, because that was and 110 00:06:20,480 --> 00:06:22,600 Speaker 1: and Barry just to point out, like that was not 111 00:06:23,600 --> 00:06:29,560 Speaker 1: an investment mistake, that was an investor mistake. Right. If 112 00:06:29,640 --> 00:06:32,320 Speaker 1: you had just stuck to the plan, which is rebalance 113 00:06:32,400 --> 00:06:34,880 Speaker 1: each year, you would have been fine. It would have 114 00:06:34,880 --> 00:06:37,920 Speaker 1: been painful, but not nearly as painful as it turned 115 00:06:37,960 --> 00:06:38,279 Speaker 1: out to be. 116 00:06:38,440 --> 00:06:41,279 Speaker 2: And I would bet the Dave's Value Fund did pretty 117 00:06:41,320 --> 00:06:44,039 Speaker 2: well in the early two thousand, certainly relative to the 118 00:06:44,160 --> 00:06:46,200 Speaker 2: growth fund for sure. 119 00:06:46,480 --> 00:06:48,479 Speaker 1: For sure, So you would have been protecting that. You 120 00:06:48,480 --> 00:06:53,919 Speaker 1: would have been systematically buying relatively low and selling relatively 121 00:06:54,040 --> 00:06:57,719 Speaker 1: high along the way systematically, because it's just what you do, 122 00:06:58,240 --> 00:06:59,400 Speaker 1: and that's called rebalancing. 123 00:06:59,640 --> 00:07:05,640 Speaker 2: So the behavior gap creates this space between how the 124 00:07:05,760 --> 00:07:11,520 Speaker 2: investment performs and how the investor performs. How big can 125 00:07:11,600 --> 00:07:15,960 Speaker 2: that gap get? How large does the behavior gap between 126 00:07:16,120 --> 00:07:19,760 Speaker 2: actual fun performance and investor returns become? 127 00:07:21,160 --> 00:07:23,720 Speaker 1: Yeah, this is really problematic because there are a couple 128 00:07:23,720 --> 00:07:26,720 Speaker 1: of different studies and none of them are great. My 129 00:07:27,000 --> 00:07:30,040 Speaker 1: experience with it is more antidotal, right, Like the experience 130 00:07:30,040 --> 00:07:32,000 Speaker 1: I have, like the story I just told, I could 131 00:07:32,000 --> 00:07:35,280 Speaker 1: tell twenty of those stories, right given, I mean, did 132 00:07:35,320 --> 00:07:39,040 Speaker 1: anybody listening become a real estate investor in No? Seven? Right? 133 00:07:39,160 --> 00:07:43,240 Speaker 1: Like over, you know, we don't have to even go 134 00:07:43,360 --> 00:07:47,800 Speaker 1: into the crypto NFT situation, right, but just over and 135 00:07:47,840 --> 00:07:51,080 Speaker 1: over we do it. But morning stars numbers I think 136 00:07:51,160 --> 00:07:54,160 Speaker 1: are my favorite, and that always puts it around. It's 137 00:07:54,280 --> 00:07:57,080 Speaker 1: a percent, a percent and a half over long periods 138 00:07:57,080 --> 00:08:00,400 Speaker 1: of time, which when we're all scraping for twenty five 139 00:08:00,400 --> 00:08:03,960 Speaker 1: basis points, you know, running around trying to eke out 140 00:08:03,960 --> 00:08:08,880 Speaker 1: the last bit of return, then this behavior gap that 141 00:08:09,000 --> 00:08:12,160 Speaker 1: costs us one hundred and twenty you know a point 142 00:08:12,200 --> 00:08:14,160 Speaker 1: to a point in a quarter is something worth paying 143 00:08:14,160 --> 00:08:14,640 Speaker 1: attention to. 144 00:08:14,840 --> 00:08:19,440 Speaker 2: Yeah, especially as as how that's compounded over time, it 145 00:08:19,480 --> 00:08:23,720 Speaker 2: can really add up to something substantial. So let's talk 146 00:08:23,760 --> 00:08:28,400 Speaker 2: about where the behavior gap comes from. It sounds like 147 00:08:29,080 --> 00:08:32,240 Speaker 2: our emotions are involved. It sounds like fear and greed 148 00:08:32,360 --> 00:08:35,800 Speaker 2: is what drives the behavior gap. Tell us what you've found. 149 00:08:36,800 --> 00:08:40,760 Speaker 1: Yeah, I originally it's funny when I originally this was 150 00:08:40,800 --> 00:08:43,920 Speaker 1: sort of I felt like this was a discovery, you know, 151 00:08:44,160 --> 00:08:46,520 Speaker 1: cute of me because lots of other people have been 152 00:08:46,520 --> 00:08:48,559 Speaker 1: writing about it for years. But I was trying to 153 00:08:48,559 --> 00:08:51,120 Speaker 1: put a name on this gap, and I called it 154 00:08:51,120 --> 00:08:54,280 Speaker 1: originally the emotional gap. I'm really glad I changed the 155 00:08:54,400 --> 00:08:56,760 Speaker 1: name to the behavior at for the book. But to me, 156 00:08:56,880 --> 00:08:59,480 Speaker 1: there was just I couldn't explain it other than or 157 00:08:59,600 --> 00:09:04,160 Speaker 1: invest behavior. And I think when we understand how we're wired, 158 00:09:04,200 --> 00:09:06,240 Speaker 1: and I can't remember who was a Buffett that said, 159 00:09:06,360 --> 00:09:08,480 Speaker 1: of course we could just we can always attribute it 160 00:09:08,480 --> 00:09:12,199 Speaker 1: to Buffett if it was smart. But it was. If 161 00:09:12,280 --> 00:09:15,440 Speaker 1: you want to design a poor behavior, a poor investor, 162 00:09:15,880 --> 00:09:20,000 Speaker 1: design a human right, we're we're hard wired and it's 163 00:09:20,080 --> 00:09:24,120 Speaker 1: kept us alive as a species to get more of 164 00:09:24,160 --> 00:09:27,160 Speaker 1: the stuff that's giving us security or pleasure, and to 165 00:09:27,360 --> 00:09:29,800 Speaker 1: run as fast as we can. Like I don't really care, Berry, 166 00:09:29,840 --> 00:09:31,839 Speaker 1: I don't care what you tell me. If my hand's 167 00:09:31,840 --> 00:09:34,400 Speaker 1: on a burning stove, I'm going to take it off. 168 00:09:34,440 --> 00:09:36,240 Speaker 1: There are all the facts and figures you want at me. 169 00:09:36,640 --> 00:09:38,760 Speaker 1: Try to be rational with me all day long. I'm 170 00:09:38,880 --> 00:09:42,520 Speaker 1: I'm taking my hand off. And somehow, especially given the 171 00:09:42,559 --> 00:09:46,320 Speaker 1: sort of circus that exists around investing, you know where 172 00:09:46,320 --> 00:09:48,840 Speaker 1: you got people yelling and screaming by sell buy sell 173 00:09:48,920 --> 00:09:53,960 Speaker 1: all day long. We translate market down, mark it down. 174 00:09:54,000 --> 00:09:56,400 Speaker 1: Oh no, if I don't do something, and we project 175 00:09:56,400 --> 00:09:59,000 Speaker 1: the recent past and definitely in the future, and I've 176 00:09:59,000 --> 00:10:01,600 Speaker 1: seen people actually do the ca oculations. If the last 177 00:10:01,679 --> 00:10:05,120 Speaker 1: two weeks continue, in fifty two weeks, I'm gonna have 178 00:10:05,160 --> 00:10:09,760 Speaker 1: no money left, right, so market's going to zero. Yeah, 179 00:10:09,800 --> 00:10:13,599 Speaker 1: we have this recency bias problem. We have being hardwired 180 00:10:13,600 --> 00:10:17,240 Speaker 1: for security and pleasure. We have safety heard behavior when 181 00:10:17,280 --> 00:10:21,280 Speaker 1: all your neighbors are yelling, right, it's really hard not to, 182 00:10:22,320 --> 00:10:24,920 Speaker 1: you know. And it was a buffet quote. Right, I 183 00:10:24,920 --> 00:10:28,640 Speaker 1: want to be greedy when everybody else is fearful, and 184 00:10:28,679 --> 00:10:31,480 Speaker 1: fearful when everybody else is greedy. And that's cute to say, 185 00:10:32,160 --> 00:10:33,960 Speaker 1: But when you've actually been punched in the face, you 186 00:10:34,000 --> 00:10:35,240 Speaker 1: behave a little differently, right. 187 00:10:35,720 --> 00:10:38,400 Speaker 2: So the other thing that I noticed that you've written 188 00:10:38,440 --> 00:10:42,000 Speaker 2: about regarding the behavior gap is how much we focus 189 00:10:42,080 --> 00:10:45,839 Speaker 2: on issues that are completely out of our control. What's 190 00:10:45,840 --> 00:10:49,760 Speaker 2: happening with markets going up and down? Who is Russia invading? 191 00:10:49,800 --> 00:10:52,800 Speaker 2: What's happening in the Middle East? When's the FED gonna 192 00:10:52,800 --> 00:10:56,199 Speaker 2: cut or raise rates? All of these things are completely 193 00:10:56,320 --> 00:10:59,720 Speaker 2: outside of not only our control but our ability to 194 00:10:59,760 --> 00:11:04,319 Speaker 2: fore cast what should investors be focusing on instead. 195 00:11:05,000 --> 00:11:11,600 Speaker 1: Yeah, I think portfolio construction, when done correctly, it takes 196 00:11:11,679 --> 00:11:15,559 Speaker 1: into account the weighty evidence of history, and the weighty 197 00:11:15,600 --> 00:11:19,800 Speaker 1: of evidence of history includes all of those events that 198 00:11:19,840 --> 00:11:24,000 Speaker 1: we couldn't have forecasted before, So we shouldn't be surprised 199 00:11:24,640 --> 00:11:28,160 Speaker 1: that things that we didn't think about will show up 200 00:11:28,200 --> 00:11:30,760 Speaker 1: next year, next week, and those things that we didn't 201 00:11:30,800 --> 00:11:34,319 Speaker 1: think about will have the greatest impact on our portfolio. 202 00:11:34,880 --> 00:11:37,640 Speaker 1: So it's literally like the unknown unknowns that will have 203 00:11:37,679 --> 00:11:40,800 Speaker 1: the greatest impact. Will design the portfolio with that in mind, Well, 204 00:11:40,800 --> 00:11:42,839 Speaker 1: how do you do that? We'll use the weighty evidence 205 00:11:42,880 --> 00:11:44,560 Speaker 1: of history because it's been going on for a long time. 206 00:11:45,000 --> 00:11:47,400 Speaker 1: So I think the way to focus on what, like 207 00:11:47,480 --> 00:11:51,040 Speaker 1: the thing you can control the most is portfolio construction, 208 00:11:51,720 --> 00:11:54,959 Speaker 1: asset allocation and costs. Like if we just get clear 209 00:11:55,000 --> 00:11:58,800 Speaker 1: about that the portfolio is designed. Here's a question ask you. 210 00:11:58,840 --> 00:12:01,960 Speaker 1: I've been asking this question as like a game for 211 00:12:02,000 --> 00:12:06,160 Speaker 1: the last five years. Why is your portfolio built the 212 00:12:06,160 --> 00:12:08,960 Speaker 1: way it is? And the most common answers like I 213 00:12:09,040 --> 00:12:12,400 Speaker 1: heard about it on the news. This really smart people 214 00:12:12,520 --> 00:12:18,120 Speaker 1: whisper everything about it. An economist, right, so you, But 215 00:12:18,720 --> 00:12:23,240 Speaker 1: the correct answer is this portfolio is designed intentionally to 216 00:12:23,280 --> 00:12:26,719 Speaker 1: give me the greatest chance of meeting my own goals. Well, 217 00:12:26,760 --> 00:12:28,560 Speaker 1: those are the things you can focus on. Huh. 218 00:12:29,080 --> 00:12:33,080 Speaker 2: Quite intriguing. So to wrap up, when investors chase hot 219 00:12:33,120 --> 00:12:36,880 Speaker 2: funds or ETFs or sectors or whatever is the flavor 220 00:12:36,920 --> 00:12:40,679 Speaker 2: of the moment, there's a tendency to buy high, and 221 00:12:40,920 --> 00:12:45,559 Speaker 2: if subsequently they get out of these positions or sell 222 00:12:45,600 --> 00:12:49,599 Speaker 2: into a panic or market correction, they're all but guaranteed 223 00:12:49,640 --> 00:12:53,680 Speaker 2: to generate a performance worse than the fund itself. To 224 00:12:53,840 --> 00:12:57,800 Speaker 2: avoid succumbing to the behavior gap, you must learn to 225 00:12:57,960 --> 00:13:01,679 Speaker 2: manage your own behavior. I'm Barry Ritolts, and this has 226 00:13:01,679 --> 00:13:07,480 Speaker 2: been Bloomberg's at the money. Ain't misbehaving, I'm saving my value.