Different investors have different problems, but from an investment management standpoint, there’s a problematic common denominator. Here’s a quote from a recent Forbes Article illustrating what that looks like:
“Over the past 20 years, from 1996 through 2015, the S&P 500 returned 8.2%. Over the same time period, per DALBAR, the average dollar invested in U.S. equity mutual funds returned 4.7%.”
The Behavior Gap is real. It’s the biggest risk to long term success and to your value proposition. If you are an advisor or anyone with influence on client assets, the ability to minimize this has to be part of your value proposition. Investors need help – they can’t do it alone. Their behavior has been a detriment to success and advisors who truly educate and deploy necessary tools to help shrink this gap are needed.
Behavioral biases are either cognitive or emotional. Knowing they exist is the first step and recognizing how to minimize them is key. Cognitive Biases (think Math) can be combated with logic. The solution is to educate. Emotional Biases (think the fear of heights) on the other hand, aren’t minimized by logic. Logical explanation is irrelevant in the face of emotion. The solution is to adapt.
The quote above that illustrates an 8.2% return for the S&P from 1996 to 2015 fails to mention that full exposure to the index over that time period would have put an investor through 2 drawdowns of over 50%. In other words, you would have watched your assets be cut in half…twice. No wonder the gap is there, that’s a tough thing to sit through for any investor. If you put investors through massive drawdowns, no amount of education can fend off the emotional decisions made in the heat of the moment. Something more is needed to manage that behavioral risk – it’s the biggest risk to your value.
Value is not producing new strategies and theories that can outperform the market. History shows most investors can’t stick with them long enough to realize the benefit anyway. Value is helping investors minimize the behavior gap. What they get of what the market ultimately gives matters. In a highly correlated market that’s starved for yield due to central bank policy, the ability to adapt is critical. Market volatility will come – that’s not the problem – investor reaction to volatility is.
As an advisor, what tools are you using to shrink the gap and protect your value? Are you educating on the how and why of your portfolios? Are you deploying a system that’s founded in research and a process that cannot be overridden by emotion? If you are not, now is a good time to start.