How Could the Behavior Gap Affect Your Investments During This Time of Market Volatility?

“It turns out my job was not to find great investments, but to help create great investors,” writes Carl Richards, author of “The Behavior Gap.”¹ From increasing our budget mindfulness to taking a steadier approach to investing, Richards has drawn attention to the way our unexamined behaviors and emotions can be our detriment when it comes to living a happy and financially sound life. 

In many cases, we make poor financial decisions when experiencing panic or anxiety as a result of personal or widespread events. In the past few weeks, the Coronavirus is one such event that has affected nearly every industry and home as people and governments take action to keep themselves and their community safe. The virus continues to evoke fear and panic as the number of affected individuals rises.

On Feb. 20, 2020, the S&P/TSX Composite hit its peak so far this year at 17,944 points while the Dow Jones Industrial Average (DJIA) was at 29,219 points.  The lowest trough was March 23rd, when 1the S&P/TSX Composite Index dropped to 11,228 and the DJIA went to 18,591 points as investors worried about the unknown financial impact of this health crisis.  There has been some market recovery, and as of Aug 31st the S&P/TSX was at 16,514 and the DJIA at 28,430.  Some stocks, in particular US technology or healthcare stocks, have enjoyed strong returns in recent months.  Where investors have an effective diversified portfolio, with exposure to various geographic areas, industries, and asset classes, their accounts are often up nicely year to date.

Whether facing a devastating event or an exciting advancement, people frequently make money decisions as a response. Below we discuss the common financial behaviors driven by such circumstances.

The Behavior Gap Explained 

Coined by Richards, “the behavior gap” refers to the difference between a smart financial decision versus what we actually decide to do. Many people miss out on higher returns because of emotionally driven decisions, creating a gap —  “the behavior gap” — between their lower returns and what they could have earned.

4 Common Emotions that Can Create a Behavior Gap 

#1: Excitement When Stocks Are High 

Whether in a bull market or witnessing the hype from a product release, many investors may feel tempted to increase their risks or attempt to gain from emerging investments when stocks are high. This can lead to investors constantly readjusting their portfolios as the market itself experiences upswings. An investor who follows such patterns is likely to do the same with declines and may end up trying to time the market time and again amidst its inevitable, unpredictable movement.

#2: Fear When Stocks Are Low

As a response to the Coronavirus, the market has seen losses as many investors feel the need to choose more secure investments and avoid uncertain or seemingly unsafe investments. When stocks are low, a common response may be to sell and effectively miss out on potential long-term gains. 

#3: Engagement in the Search for Alpha

Alpha is a way of describing the active return on an investment, measuring  the performance of an investment against a market index or benchmark.  The excess return of an investment relative to the return of a benchmark index is the investment’s alpha.3  Throughout our lives, this emotional desire to make money or build security in wealth is natural.  As such, many seek the help of a financial advisor to procure above-average returns, otherwise known as “alpha.”¹ However, in this search for “alpha,” our humanness — our emotions and our behaviors — may lead us astray. Ironically, studies done by DALBAR have calculated the “average investment return” as compared to investor returns and have shown that investor returns are lower.¹ The underlying emotional desire and pursuit of money is exactly the recipe for unwise behaviors in response to emotions — but only if left unchecked. 

#4: Short-Term Anxiety and Focus

As humans, viewing aspects of our lives through the lenses of current circumstances is normal. One emotional response to any event, however, is letting the moment consume us, especially if faced with grave consequences —  from our personal health being compromised to the loss of loved ones. Many may find it difficult in these times to both think long-term and to remember logic. However, making a rash decision can inhibit the long-term benefit that comes from maintaining a balanced perspective without reactionary behavior. 

How to Lessen the Behavior Gap for Your Financial Health 

At any given point, the market can go up, down or it can remain the same. While many aspects of the virus are out of our control, one thing we can control right now is how we handle our financial strategy. 

In the past, the market has recovered in response to epidemics with an average of 17.17 percent over time.2  While no two situations are alike, remembering the likelihood of recovery over time — and the market’s nearly inevitable up-and-down movement — can provide a more logical angle to calm the nerves. 

If you’re experiencing financial anxiety in response to the coronavirus, take a breath and also remember the potential for long-term gains. Of course, you can and should always reach out to your advisor for further clarification and advice, and let us know if there are changes in your personal or financial situation that may impact our recommendations.  During Ontario's state of emergency, our joint advisor team is available by phone, email, and video-chat.  It's another way that we are here for you.

• Elaine Kelly, MBA CFP, FCSI,  Senior Investment Advisor, Manulife Securities Incorporated
• David Wyatt, BA, B.Comm, CFP, Senior Investment Advisor, Manulife Securities Incorporated 
• Katlin Wyatt, BA, Investment Advisor, Manulife Securities Incorporated
• Diana Kancko, Executive Assistant, Manulife Securities Incorporated
• Terry Wyatt, Executive Assistant, Manulife Securities Incorporated