Closing the Behavior Gap

I once went to an investment seminar at my local library. It was attended by a handful of folks who had little or no experience with investing and were looking for someone to put them on the right track. The guy leading the session held up a copy of the Globe and Mail business section and encouraged us all to read it every day so we could learn what was happening in the economy and apply it to our investments.

That is some of the worst financial advice I’ve ever heard, and if Carl Richards had been there I imagine he would have thrown a few rotten eggs and tomatoes. Richards’ new book, The Behaviour Gap: Simple Ways to Stop Doing Dumb Things With Your Money, spends most of its 178 pages encouraging investors to ignore the headlines and focus on the real determinant of financial success or failure: ourselves.

“Forget about what’s going on in China or global demand for the dollar or the price of gold,” Richards writes. “While we’re worrying about those things, we could be doing things that actually make a difference in our financial lives—like working or trying to figure out how to save or earn a little more.”

Richards is a financial planner and a New York Times blogger who has a remarkable talent for distilling his insights into napkin sketches. His book sets out to discover why Dalbar studies demonstrate that equity investors have underperformed the market by over 4% annually over the last 20 years. The primary reason isn’t high fees:  if that’s all it were, the difference would be much smaller. Rather, it’s a behavior gap—Richards’ term for the difference between what investors should do and what they actually do.

Stop smoking, start saving

One of the anecdotes Richards shares comes from a former doctor who changed careers to become a financial advisor. The advisor regularly hears from clients who are desperately seeking higher returns while ignoring far more important parts of their financial lives. They remind him of a former patient who loved to debate about which medication was the best treatment for his high blood pressure—but he refused to stop smoking.

I encourage investors to remember this story the next time they want to make adjustments to their portfolios Even the Global Couch Potato is more than adequate to help you reach your financial goals if you’re a disciplined investor. I would estimate that will outperform 80% to 90% of individuals (on a risk-adjusted basis) over any period longer than 10 years. It’s not perfect, and you might be able squeeze out as much as a percentage point with more diversification or cheaper products. But chances are your behavior has a bigger influence on your returns than the specific funds in your portfolio.

For example, if you’re not saving enough, or if you’re carrying credit card debt, it makes no sense to worry about giving your investment returns a boost. Your precise allocation to US stocks, Vanguard versus iShares, or whether you use currency hedging—all of that is meaningless by comparison. Saving more and paying down debt will always swamp these decisions.

See Carl Richards live

If you’d like to hear more of Richards’ insights on the behavior gap, here’s your chance. PWL Capital Inc. is bringing Richards to Canada for a series of presentations in Toronto, Ottawa and Montreal. I have accepted an initiation to attend the Toronto event, and PWL is offering a limited number of invitations to Canadian Couch Potato readers in each of the three cities.

The Toronto presentation will take place on Tuesday, May 22, at 6 pm. The Ottawa and Montreal events will be held on Wednesday May 23 at 11:45 am and 6 pm, respectively.

If you would like to be entered into the draw for free tickets, email me with the answer to the following skill-testing question: What is the name of the firm that employs Richards as its director of investor education?

Please include your full name and indicate which of three events you would like to attend. Entries must be received by midnight on Sunday, April 29. I’ll announce the winners in next Monday’s post.