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Quantifying the Behavior Gap
The behavior gap is the difference between the return investors actually earn and the return of the investments themselves. If investors could capably time financial markets, you’d see that investor returns were higher than the investment returns, indicating that investors bought low and sold high.
It turns out that most research finds the opposite result. Investors tend to underperform the returns of the underlying investments, which means investors instead tend to buy high and sell low. Russel Kinnel at Morningstar has examined this in substantial detail. Over the 10-year period ending December 2012, here were the results:
Over this period, the gap averaged out to 1.44 percent, was particularly bad in international stock funds and wasn’t great in municipal bonds either. I suspect (as Kinnel does) that the municipal bond result is being driven by the 2010 and 2011 reaction to worries about default risk that did not materialize.
It’s also interesting to note that the gap was positive in every single category. Kinnel also examined three- and five-year results ending December 2012 and found that the number was positive in every category except for balanced funds in both periods.
At some level, the percentage difference in returns speak for themselves, but it’s even more astounding to think about differences in wealth over various time horizons if you are underperforming what you could have earned by 1.44 percent per year. Using the return percentages in the “Average” row, $1,000 would have grown to $1,927 after 10 years if you had earned the fund returns while it would have grown to just $1,683 if you had earned the investor returns. This is a 14.5 percent difference in ending period wealth.
Random Links and Commentary of the Week
I haven’t shared any music links in a while so here are some tunes I’ve been enjoying:
Jared Kizer is the director of investment strategy for The BAM ALLIANCE. See our disclosures page for more information.
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Marc Cobe

Well written article, I am impressed by the author's style. Goes well brevity and meaning. Always enjoy reading these articles helps a lot to learn in the field of finance.
at 6/6/2013 1:20 PM

Thanks for the feedback

Glad you're enjoying the posts!

at 6/6/2013 7:01 PM

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