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At the Money: Avoiding the Behavior Gap · Masters in Business

• 0:00
  Speaker 1: In misbehaving saving me?
• 0:05
  Speaker 2: How many times has this happened to you? Some interesting
• 0:09
  Speaker 2: new fund manager or ETF is putting up great numbers,
• 0:13
  Speaker 2: sometimes for years, and you take the plunge and finally
• 0:17
  Speaker 2: buy it. It's a hot fund with tremendous performance. But
• 0:21
  Speaker 2: after a few years you review your portfolio and wonder, hey,
• 0:25
  Speaker 2: how come my returns aren't nearly as good as expected.
• 0:28
  Speaker 2: You may be experiencing what has become known as the
• 0:32
  Speaker 2: behavior gap. It's the reason your actual performance is much
• 0:37
  Speaker 2: worse than the fund you purchase. I'm Barry Riddolts, and
• 0:41
  Speaker 2: on today's edition of At the Money, we're going to
• 0:45
  Speaker 2: discuss how to avoid suffering from the behavior gap. To
• 0:49
  Speaker 2: help us unpack all of this and what it means
• 0:51
  Speaker 2: for your portfolio, let's bring in Carl Richards. He's the
• 0:55
  Speaker 2: author of The Behavior Gap, Simple Ways to Stop Doing
• 1:00
  Speaker 2: Things with Money. The book focuses on the underlying behavioral
• 1:04
  Speaker 2: issues that lead people to make poor financial decisions. So Carl,
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  Speaker 2: let's just start with a basic definition. What is the
• 1:14
  Speaker 2: behavior gap?
• 1:15
  Speaker 1: Thanks? Verry, super fun to chat with you about this.
• 1:18
  Speaker 1: So I this is going back now twenty years right,
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  Speaker 1: like I just stumbled upon this early on in my
• 1:25
  Speaker 1: work with investors that we would get all excited. I
• 1:28
  Speaker 1: would get all excited as you, exactly as you said,
• 1:31
  Speaker 1: like we would do some performance review. We would find
• 1:34
  Speaker 1: some fund we thought was great. Of course, past performance
• 1:37
  Speaker 1: is no indication of future results. But what's the first
• 1:39
  Speaker 1: thing you look at when you decide to make Yeah,
• 1:42
  Speaker 1: past performance, get all excited about it, and then you
• 1:45
  Speaker 1: have this inevitable letdown. And so I think the easiest
• 1:48
  Speaker 1: way to describe this is imagine you open the newspaper
• 1:51
  Speaker 1: and there's an there's an advertisement, Remember the old fashioned newspaper, right,
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  Speaker 1: There's an advertisement for a mutual fund that says ten
• 1:59
  Speaker 1: year average annual return of ten percent. Well, that's the
• 2:03
  Speaker 1: investment return. And I think we all forget that investments
• 2:07
  Speaker 1: are different than investors, and so the behavior gap is
• 2:11
  Speaker 1: the difference between the investment return and the return you
• 2:16
  Speaker 1: earn as an investor in your account. And my experience
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  Speaker 1: and the data show that often individual investors underperform the
• 2:26
  Speaker 1: average investment. So it's this well intentioned behavior of finding
• 2:31
  Speaker 1: the best investment is generating a suboptimal result for us
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  Speaker 1: as investors.
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  Speaker 2: So what's the underlying basis for that?
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  Speaker 1: Gap.
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  Speaker 2: I'm assuming, especially if we're talking about a hot fund,
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  Speaker 2: the fund has had a great run up, people buy,
• 2:49
  Speaker 2: if not the top, well certainly after it's had a
• 2:52
  Speaker 2: big move, and then a little bit of mean reversion
• 2:55
  Speaker 2: comes back into it. The fund does poorly for a
• 2:58
  Speaker 2: couple of years and then kind of goes back to
• 3:00
  Speaker 2: where it was. Is just as simple as buying high
• 3:04
  Speaker 2: and being stuck with it low? Is it that simple?
• 3:07
  Speaker 1: Yeah, it's interesting. Let me just tell you a quick story,
• 3:09
  Speaker 1: and this is about all great investment stories are about
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  Speaker 1: your father in law. Right, So I remember my father
• 3:15
  Speaker 1: in law in ninety seven, ninety eight, ninety nine, he
• 3:19
  Speaker 1: had an investment advisors was named Carter. I remember all this,
• 3:23
  Speaker 1: and he owned and I can name specific funds because
• 3:26
  Speaker 1: these things are not the problem. The fund didn't make
• 3:30
  Speaker 1: the mistake, right, So Alliance Premier Growth, if you remember
• 3:34
  Speaker 1: ninety seven, ninety eight, ninety nine, just you know he
• 3:37
  Speaker 1: owned Alliance Premier Growth, and he owned Davis New York Venture,
• 3:41
  Speaker 1: so a go go growth fund and something that was
• 3:44
  Speaker 1: classically value. And at the end of ninety seven he
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  Speaker 1: looks at his returns and he's like, why do we
• 3:50
  Speaker 1: own this? This Davis this value fund. Why do we
• 3:53
  Speaker 1: own this thing? Carter talks him into rebalancing, which means
• 3:57
  Speaker 1: he took some from Alliance Premier Growth it to Davis,
• 4:00
  Speaker 1: opposite of what he felt like doing. Right. Ninety eight
• 4:04
  Speaker 1: comes wrong, same thing, Alliance Premier Growth knocks it out
• 4:07
  Speaker 1: of the park. Davis only does like twelve percent or something, right,
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  Speaker 1: father in law complains. Carter says, hey, please come on, like,
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  Speaker 1: this is just this is just what we do. We're
• 4:18
  Speaker 1: actually going to do the opposite of what you feel.
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  Speaker 1: We're going to sell some Alliance Premier Growth. We're going
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  Speaker 1: to rebalance into Davis ninety nine, right, And I can't
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  Speaker 1: call the exact numbers, but if I Alliance did something
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  Speaker 1: like fifty four percent and Davis only did seventeen, and
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  Speaker 1: my father in law was like, that's it, that's it.
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  Speaker 1: And I remember New Year, like over Christmas, over the
• 4:42
  Speaker 1: Christmas holiday of ninety nine, right, and you know what
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  Speaker 1: happens next, he tells me, He's like, yeah, I finally
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  Speaker 1: had enough. I fired those Davis, that Davis New York
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  Speaker 1: Venture Fund and moved all the money to Alliance Premier
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  Speaker 1: Growth just in time. You know, we had another He
• 4:55
  Speaker 1: felt like a hero for January February and then March
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  Speaker 1: of two thousand, just in time to get its head
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  Speaker 1: taken off. And we repeat that over and over, and
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  Speaker 1: it's kind of wired into us. So's it's challenging. You
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  Speaker 1: want more of what gives you security or pleasure, and
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  Speaker 1: you want to run away from things that cause you
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  Speaker 1: pain as fast as possible. And somehow we've translated that
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  Speaker 1: into by high and so low and repeat until broke. Huh.
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  Speaker 2: And I happen to have the number one of that
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  Speaker 2: series of lithographs you did, repeat until yes, hanging in
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  Speaker 2: my office. And let's put a little a little meat
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  Speaker 2: on the bones if you were heavily invested in any
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  Speaker 2: fund that was heavily exposed to the Nasdaq from the
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  Speaker 2: peak in March two thousand to just two years later.
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  Speaker 2: By October of two the Nasdaq was down about eighty
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  Speaker 2: one percent pete to troth. Yeah, that's a hell of
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  Speaker 2: a haircut, losing four fifths of the value.
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  Speaker 1: Especially just I mean, I remember those conversations like there
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  Speaker 1: was I mean, this is kind of fun to poke
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  Speaker 1: fun at your father in law, right, but it wasn't
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  Speaker 1: very fun when there was like some pretty major drastic
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  Speaker 1: changes in the way the family was operating because of
• 6:12
  Speaker 1: that experience, Like it was, it was a real deal
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  Speaker 1: for lots of people, right sure, because that was and
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  Speaker 1: and Barry just to point out, like that was not
• 6:23
  Speaker 1: an investment mistake, that was an investor mistake. Right. If
• 6:29
  Speaker 1: you had just stuck to the plan, which is rebalance
• 6:32
  Speaker 1: each year, you would have been fine. It would have
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  Speaker 1: been painful, but not nearly as painful as it turned
• 6:37
  Speaker 1: out to be.
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  Speaker 2: And I would bet the Dave's Value Fund did pretty
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  Speaker 2: well in the early two thousand, certainly relative to the
• 6:44
  Speaker 2: growth fund for sure.
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  Speaker 1: For sure, So you would have been protecting that. You
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  Speaker 1: would have been systematically buying relatively low and selling relatively
• 6:54
  Speaker 1: high along the way systematically, because it's just what you do,
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  Speaker 1: and that's called rebalancing.
• 6:59
  Speaker 2: So the behavior gap creates this space between how the
• 7:05
  Speaker 2: investment performs and how the investor performs. How big can
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  Speaker 2: that gap get? How large does the behavior gap between
• 7:16
  Speaker 2: actual fun performance and investor returns become?
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  Speaker 1: Yeah, this is really problematic because there are a couple
• 7:23
  Speaker 1: of different studies and none of them are great. My
• 7:27
  Speaker 1: experience with it is more antidotal, right, Like the experience
• 7:30
  Speaker 1: I have, like the story I just told, I could
• 7:32
  Speaker 1: tell twenty of those stories, right given, I mean, did
• 7:35
  Speaker 1: anybody listening become a real estate investor in No? Seven? Right?
• 7:39
  Speaker 1: Like over, you know, we don't have to even go
• 7:43
  Speaker 1: into the crypto NFT situation, right, but just over and
• 7:47
  Speaker 1: over we do it. But morning stars numbers I think
• 7:51
  Speaker 1: are my favorite, and that always puts it around. It's
• 7:54
  Speaker 1: a percent, a percent and a half over long periods
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  Speaker 1: of time, which when we're all scraping for twenty five
• 8:00
  Speaker 1: basis points, you know, running around trying to eke out
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  Speaker 1: the last bit of return, then this behavior gap that
• 8:09
  Speaker 1: costs us one hundred and twenty you know a point
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  Speaker 1: to a point in a quarter is something worth paying
• 8:14
  Speaker 1: attention to.
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  Speaker 2: Yeah, especially as as how that's compounded over time, it
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  Speaker 2: can really add up to something substantial. So let's talk
• 8:23
  Speaker 2: about where the behavior gap comes from. It sounds like
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  Speaker 2: our emotions are involved. It sounds like fear and greed
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  Speaker 2: is what drives the behavior gap. Tell us what you've found.
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  Speaker 1: Yeah, I originally it's funny when I originally this was
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  Speaker 1: sort of I felt like this was a discovery, you know,
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  Speaker 1: cute of me because lots of other people have been
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  Speaker 1: writing about it for years. But I was trying to
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  Speaker 1: put a name on this gap, and I called it
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  Speaker 1: originally the emotional gap. I'm really glad I changed the
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  Speaker 1: name to the behavior at for the book. But to me,
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  Speaker 1: there was just I couldn't explain it other than or
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  Speaker 1: invest behavior. And I think when we understand how we're wired,
• 9:04
  Speaker 1: and I can't remember who was a Buffett that said,
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  Speaker 1: of course we could just we can always attribute it
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  Speaker 1: to Buffett if it was smart. But it was. If
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  Speaker 1: you want to design a poor behavior, a poor investor,
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  Speaker 1: design a human right, we're we're hard wired and it's
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  Speaker 1: kept us alive as a species to get more of
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  Speaker 1: the stuff that's giving us security or pleasure, and to
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  Speaker 1: run as fast as we can. Like I don't really care, Berry,
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  Speaker 1: I don't care what you tell me. If my hand's
• 9:31
  Speaker 1: on a burning stove, I'm going to take it off.
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  Speaker 1: There are all the facts and figures you want at me.
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  Speaker 1: Try to be rational with me all day long. I'm
• 9:38
  Speaker 1: I'm taking my hand off. And somehow, especially given the
• 9:42
  Speaker 1: sort of circus that exists around investing, you know where
• 9:46
  Speaker 1: you got people yelling and screaming by sell buy sell
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  Speaker 1: all day long. We translate market down, mark it down.
• 9:54
  Speaker 1: Oh no, if I don't do something, and we project
• 9:56
  Speaker 1: the recent past and definitely in the future, and I've
• 9:59
  Speaker 1: seen people actually do the ca oculations. If the last
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  Speaker 1: two weeks continue, in fifty two weeks, I'm gonna have
• 10:05
  Speaker 1: no money left, right, so market's going to zero. Yeah,
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  Speaker 1: we have this recency bias problem. We have being hardwired
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  Speaker 1: for security and pleasure. We have safety heard behavior when
• 10:17
  Speaker 1: all your neighbors are yelling, right, it's really hard not to,
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  Speaker 1: you know. And it was a buffet quote. Right, I
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  Speaker 1: want to be greedy when everybody else is fearful, and
• 10:28
  Speaker 1: fearful when everybody else is greedy. And that's cute to say,
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  Speaker 1: But when you've actually been punched in the face, you
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  Speaker 1: behave a little differently, right.
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  Speaker 2: So the other thing that I noticed that you've written
• 10:38
  Speaker 2: about regarding the behavior gap is how much we focus
• 10:42
  Speaker 2: on issues that are completely out of our control. What's
• 10:45
  Speaker 2: happening with markets going up and down? Who is Russia invading?
• 10:49
  Speaker 2: What's happening in the Middle East? When's the FED gonna
• 10:52
  Speaker 2: cut or raise rates? All of these things are completely
• 10:56
  Speaker 2: outside of not only our control but our ability to
• 10:59
  Speaker 2: fore cast what should investors be focusing on instead.
• 11:05
  Speaker 1: Yeah, I think portfolio construction, when done correctly, it takes
• 11:11
  Speaker 1: into account the weighty evidence of history, and the weighty
• 11:15
  Speaker 1: of evidence of history includes all of those events that
• 11:19
  Speaker 1: we couldn't have forecasted before, So we shouldn't be surprised
• 11:24
  Speaker 1: that things that we didn't think about will show up
• 11:28
  Speaker 1: next year, next week, and those things that we didn't
• 11:30
  Speaker 1: think about will have the greatest impact on our portfolio.
• 11:34
  Speaker 1: So it's literally like the unknown unknowns that will have
• 11:37
  Speaker 1: the greatest impact. Will design the portfolio with that in mind, Well,
• 11:40
  Speaker 1: how do you do that? We'll use the weighty evidence
• 11:42
  Speaker 1: of history because it's been going on for a long time.
• 11:45
  Speaker 1: So I think the way to focus on what, like
• 11:47
  Speaker 1: the thing you can control the most is portfolio construction,
• 11:51
  Speaker 1: asset allocation and costs. Like if we just get clear
• 11:55
  Speaker 1: about that the portfolio is designed. Here's a question ask you.
• 11:58
  Speaker 1: I've been asking this question as like a game for
• 12:02
  Speaker 1: the last five years. Why is your portfolio built the
• 12:06
  Speaker 1: way it is? And the most common answers like I
• 12:09
  Speaker 1: heard about it on the news. This really smart people
• 12:12
  Speaker 1: whisper everything about it. An economist, right, so you, But
• 12:18
  Speaker 1: the correct answer is this portfolio is designed intentionally to
• 12:23
  Speaker 1: give me the greatest chance of meeting my own goals. Well,
• 12:26
  Speaker 1: those are the things you can focus on. Huh.
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  Speaker 2: Quite intriguing. So to wrap up, when investors chase hot
• 12:33
  Speaker 2: funds or ETFs or sectors or whatever is the flavor
• 12:36
  Speaker 2: of the moment, there's a tendency to buy high, and
• 12:40
  Speaker 2: if subsequently they get out of these positions or sell
• 12:45
  Speaker 2: into a panic or market correction, they're all but guaranteed
• 12:49
  Speaker 2: to generate a performance worse than the fund itself. To
• 12:53
  Speaker 2: avoid succumbing to the behavior gap, you must learn to
• 12:57
  Speaker 2: manage your own behavior. I'm Barry Ritolts, and this has
• 13:01
  Speaker 2: been Bloomberg's at the money. Ain't misbehaving, I'm saving my value.