22 May 2024

At the Money: Avoiding the Behavior Gap

1Frameworks

4Insights

Listen

Frameworks in this episode

Finance6 steps

Behavior Gap Guardrail

Use intentional allocation and rebalancing to prevent emotion-driven return loss.

Read →

Insights & moments

The myth-busts, hot takes, explainers, and tools worth keeping.

Hot Take· 1

Hot Take10:35

The Events You Never Forecast May Matter Most to Your Portfolio

Richards argues that portfolios should not depend on accurately predicting wars, rate decisions, or other headline events. History contains repeated shocks that investors failed to anticipate, so resilience matters more than confident forecasting.

Major market-moving events are often unforeseeable.
Historical evidence already includes many unexpected disruptions.
Future surprises should be expected even when their form is unknowable.
Forecast-driven portfolio changes can create false confidence.

“we shouldn't be surprised that things that we didn't think about will show up next year, next week”
Carl Richards · 11:19

“the unknown unknowns that will have the greatest impact.”
Carl Richards · 11:34

#uncertainty#forecasting#market shocks#portfolio resilience

Explainer· 2

Explainer07:21

A One-Point Behavior Gap Can Become a Major Long-Term Cost

Richards says available studies are imperfect, but highlights Morningstar estimates placing the long-term behavior gap around one to one-and-a-half percentage points. That drag is especially significant because investors and professionals often work hard to capture improvements measured in only basis points.

Behavior-gap estimates vary across studies.
Morningstar's figures place the gap around 1% to 1.5% over long periods.
The loss is much larger than many fee or performance optimizations investors pursue.
Compounding makes a persistent annual gap increasingly consequential.

“It's a percent, a percent and a half over long periods of time”
Carl Richards · 07:51

“when we're all scraping for twenty five basis points, you know, running around trying to eke out the last bit of return, then this behavior…”
Carl Richards · 07:57

#compounding#investor returns#morningstar#portfolio performance

Explainer08:36

Why Useful Survival Instincts Produce Harmful Investment Decisions

The same impulses that push humans toward security and away from pain can become destructive in markets. Falling prices feel like immediate danger, while rising prices and crowd enthusiasm feel reassuring, encouraging investors to extrapolate trends and act at precisely the wrong moment.

Humans seek more of what creates security or pleasure.
People instinctively escape situations associated with pain.
Market losses can feel like physical danger requiring immediate action.
Recency bias projects short-term moves indefinitely into the future.
Herd behavior makes contrarian discipline difficult during extremes.

“If you want to design a poor behavior, a poor investor, design a human right”
Carl Richards · 09:12

“We translate market down, mark it down. Oh no, if I don't do something, and we project the recent past and definitely in the future”
Carl Richards · 09:48

#behavioral finance#recency bias#herd behavior#fear and greed

Story· 1

Story03:07

A Hot-Fund Switch Arrived Just in Time for the Dot-Com Crash

Carl Richards recounts how his father-in-law abandoned a value fund after watching a growth fund outperform for several consecutive years. He moved everything into the growth fund shortly before the March 2000 reversal, turning performance chasing into a costly family-level event.

The growth fund repeatedly outperformed during 1997-1999.
An adviser initially encouraged annual rebalancing into the lagging value fund.
The investor eventually fired the value fund and concentrated in growth.
The Nasdaq subsequently suffered an approximately 81% peak-to-trough decline.

“I finally had enough. I fired those Davis, that Davis New York Venture Fund and moved all the money to Alliance Premier Growth just in…”
Carl Richards · 04:45

“that was not an investment mistake, that was an investor mistake.”
Carl Richards · 06:20

#dot-com bubble#performance chasing#growth funds#investment losses