[Video] Behavior gap: Bad Market Timing Costs Investors 17% Over the Past Decade

Tim breaks down the "behavior gap" and why avoiding marketing timing and opting to stick to a well-thought-out financial plan is crucial for retirement success.

Over the years, I have read study after study after study, of how often investors do worse or have worse returns than their actual investments, whether it be an individual stock or a fund they’ve invested in. And I know you’re thinking, “How the heck does that happen, Tim?” 

Well, simple answer, bad timing. People often think they can time the market and buy and sell and beat the market. But, invariably, this line of thinking, combined with the inability of some investors to stomach volatility, has generally cost the majority of investors a great deal of money over their lives. 

For instance, according to Morningstar’s annual “Mind the Gap” study released in 2023, they say bad market timing cost fund investors 17% in gains over the past decade.

The average fund gained about 7.7% per year over the 10 years ended Dec. 2022, while the average dollar invested in mutual and exchange-traded funds earned a 6% annual return. A 1.7% gap—17% over 10 years— and again, this is the result of the bad timing of investors’ buying and selling. 

As a result of this timing, investors missed out on about one-fifth of their investments’ average net returns, which is a significant shortfall, in the investing world. 

Jeffrey Ptak, chief ratings officer for Morningstar Research, states “One of the clearer takeaways from the study is that investors are more likely to mistime their investments in highly volatile funds than they are in less-volatile funds.”

Morningstar calls this “minding the gap,” and Carl Richards calls this The Behavior Gap, which refers to the difference between investment returns and the returns that investors actually achieve, due to their behavior. So, again, it's the variance between the performance of an investment and the performance that an average investor in that investment actually experiences.

This gap often occurs because of emotional decisions made by investors. For instance, during market fluctuations, investors might react emotionally, buying or selling investments at inopportune times, driven by fear or greed. This behavior can lead to buying high and selling low, which ultimately diminishes investment returns compared to what they could have been if the investor had just stayed the course. 

Or what I often see, is that for whatever reason, an investor has sold investments and is sitting on a big chunk of cash, and they have been for a long time, and they’ve missed some really big returns in the market because they kept waiting to buy back in.  

And this is human nature, right? We’re not naturally inclined to be good investors because we are built for fight or flight.  That’s what’s kept us alive for thousands of years.

But with investing, our temperament has to be the opposite of our instincts, and that’s very difficult. There is always a reason to sell, right? Stocks are overvalued, the political climate is bad, the weather is bad, there’s a war, etc, etc….  But over time, investments generally climb a “wall of worry.” 

So, how do we prevent the behavior gap?  Well, we try reframing perspective by doing the following: 

1. Create a Plan: We construct an investment plan aligned with your goals, risk tolerance, and time horizon. And this helps you stay focused on the long term rather than reacting to short-term market movements. 

2. Stick to Your Plan: Once you've established an investment strategy, stick to it. Avoid making impulsive decisions based on short-term market fluctuations. Regularly review your plan but avoid making drastic changes unless your financial situation or goals change significantly.

Often, if clients feel very strongly one way or another, we make incremental changes to their investment policy to help with peace of mind, but this way they aren’t making an all-in bet one way or another that could really throw off their retirement. 

3. Diversify: Spread your investments across different asset classes (stocks, bonds, real estate, etc.) to reduce risk. Diversification is the only “free lunch” on Walls Street.

4. Automate Investments: If you aren’t retired or living off your investments, set up automatic contributions to your investment accounts. This helps maintain consistency and prevents emotional decision-making during market highs or lows.

5. Control Emotions: Easier said than done, right? Because for most of us, money equals emotions. But fear and greed often drive irrational decisions. The fight or flight mentality I spoke of earlier. That mentality is generally the opposite of what we need to do in the investment realm. 

6. Seek Professional Advice: Obviously, this one is self-serving for me, but I truly believe a very high percentage of people would be way better served with an advisor that focuses on their situation. For us it's those in or close to retirement. We can provide guidance, help you understand your risk tolerance, and keep you on track during turbulent market times. Many argue, including Vanguard, that this alone is worth the price of admission for hiring an advisor, helping manage emotions. 

7. Regular Review and Rebalancing: Periodically review your portfolio's performance and rebalance it if necessary. Notice I said periodically. Constant monitoring can lead to impulsive decisions and isn’t going to do you any good. It’s just going to drive you nuts. 

Bottom line: 

Remember, it's normal to feel uncertain about the market, but sticking to a well-constructed plan and avoiding emotional reactions can significantly reduce the behavior gap and improve long-term investment outcomes.

After all, the Dow Jones Industrial Average has gone from 70, in 1900, to over 37,000 today, and in that time, we’ve had two world wars, a great depression, many recessions, an oil embargo, Vietnam, Iraq wars and many other conflicts. So stay the course.

A CERTIFIED financial planner™ professional can help you plan for your retirement. Schedule a call today so we can talk about your situation. 

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