Hello, welcome to the Investor's Bookshelf. Today, we are going to discuss the book The Behavior Gap: Simple Ways to Stop Doing Dumb Things with Money by Carl Richards. From the title, you might be curious: what is the most important thing in personal finance? This book tells us that overcoming the influence of emotions and striving to create a "customized" financial plan are the most important aspects of making correct financial decisions.
Many of us are involved in personal finance—some trade stocks, others buy mutual funds, bonds, gold, or real estate; some even invest in antiques. In short, we follow whatever is popular. We hope to have "experts guide us," we hope to find the "perfect investment plan," and we even think that by monitoring the market daily, listening to the news, analyzing historical data, and combining our own experiences, we can make the right choices and profit from them. But in reality, even if we do all this, we still can't make money and may even suffer significant losses. This is because, when making decisions, we are often influenced by emotions like fear and greed. There is always a gap between what we should do and what we actually do. The author calls this gap the "behavior gap."
We know that many companies try to quantify the impact of investor behavior on actual investment returns. Morningstar and Dalbar, Inc. have conducted extensive research and found that investors' actual returns on stock mutual funds are much lower than the average returns of the funds themselves. In other words, there is a gap between the two, and this gap is the "behavior gap." This means that for mutual fund investments, if we simply invest in a regular stock mutual fund and hold it without making changes, we can earn more money. However, most investors abandon this easy money. They continuously transfer money in and out of stock mutual funds, and their timing is often poor—resulting in significant losses. Therefore, the author believes that investing is essentially a choice behavior influenced by emotions. What makes investing more effective is not the market conditions but our own decisions.
The author of this book is Carl Richards, a Certified Financial Planner™ from Park City, Utah. He is also the founder of a portfolio design company. He frequently contributes to The New York Times and Morningstar Advisor. He enjoys using a marker to sketch on napkins or other scraps of paper to explain complex financial issues. Both his viewpoints and this method are refreshing and insightful; some even find his work highly valuable. As a result, he wrote this book.
This book mainly covers two aspects: first, how to overcome the influence of emotions, and second, how to create a "customized" financial plan.
Part One
Let's first talk about the influence of emotions on personal finance. The impact of emotions on human behavior is pervasive, and it affects us at all times and in all places. Especially when making financial decisions, we often fall into emotional traps. So, what emotions influence us?
One of them is fear and greed. We all know that the key to making profits is to "buy low and sell high," but we are often influenced by emotions and end up "chasing the highs and selling the lows." When we are rational, we know that this is wrong, but every time we make a decision, we make the same mistake. We are always so forgetful. We repeatedly make the same mistakes, eventually leading to bankruptcy or huge losses. For example, in 2002, when the U.S. stock market crashed, people withdrew their investments out of fear; but in 2004, when the stock market surged, people invested recklessly, with some even using their homes as collateral to buy stocks.
The author often has conversations like this with clients:
In 2009, when the stock market plummeted, three of the author's clients suffered huge losses and came to him for advice:
Client: "Hey, Carl, we think it's time to sell."
Author: "Do you mean we should sell a stock just because its market value has dropped by 30%?"
Client: "Well... you know... should we just sit there and watch it continue to fall?"
Author: "Buddy, the loss has already occurred. You might want to sell, but is now really the right time to do so?"
Client: "We are so scared!"
Author: "Fear is normal, but letting fear control your actions is not a good idea."
Client: "But it hurts so much! If the stock keeps dropping at this speed, we will have nothing by the end of the year."
Author: "In fact, stocks are riskier when their prices are high than when they are where they are now. But back then, you were happy holding onto them. Why sell now?"
Client: "So, what should we do?"
Author: "Do nothing. Wait until your mind cools down a bit and then re-evaluate whether your investment plan needs adjustment."
Such conversations happen often, and even the author is constantly influenced by emotions. The author lives in Park City, Utah, where skiing is very popular. So, he bought four pairs of skis, each suited for different types of snow conditions. One time, a friend invited him to ski, and he went to his garage, staring at the four pairs of skis, unsure of which one to choose. As the time to decide came closer, he still couldn't make up his mind. Under his friend's constant urging, he finally chose his favorite pair: it was lightweight, fast, and perfect for cross-country skiing. This experience had a big impact on him. He realized that the time, energy, and money he had spent gathering those four pairs of skis was meant to ensure he had the best tool for any condition. But when it came time to choose, those skis made him feel powerless.
So, he decided to get rid of the other three pairs and keep only the one he liked the most. Although this pair of skis was not perfect for every type of snow, it performed well on most trails and was especially good on the types of trails he enjoyed the most. Now, the author no longer had to agonize over which pair of skis to take—he only had one choice, and all he had to do was pick it up and go. Even if he encountered a trail that the skis weren't suited for, he believed that with his experience, adaptability, and a bit of luck, he would be fine.
You see, emotions can influence how we make decisions. Isn't that interesting? In fact, this situation is very common in the field of personal finance. Many people believe that making excellent financial decisions means being flawless, considering every possibility. You have to be cautious of all potential risks and invest in every market. You must constantly revise your predictions for future markets and strive for perfection, so that you can be confident and always on top. You must have a thorough understanding of financial market dynamics, and you must tighten your belt and save money.
These ideas actually stem from fear. We instinctively fear life's uncertainty and its ups and downs. Therefore, we make various plans in the hope of controlling our future. We think that if we do this, bad things won't happen; if we sell stocks now, we can avoid the market crash; if we target our investments precisely, our financial security will be guaranteed; if we've worried about everything in advance, we’ll be able to face any bad news calmly when it arrives.
The problem is that the real world is very complex, and we cannot predict what will happen in the future. This means that most of our plans are useless. Moreover, we often treat greed and fear as motivators, but they are essentially the same thing. Our greed comes from fear—these two emotions influence our behavior, causing us to waste time and money on things that really don't matter.
Dr. Rachel Naomi Remen, the founder of the American Mind-Body Health Movement, believes that economic crises are opportunities for people to engage in spiritual introspection. She argues that our financial decisions often reflect personal confusion or anxiety. If you feel anxious, you may seek ways to feel safer, to feel like you are part of the group. This could mean buying the same car and clothes as your neighbors or spending money on expensive vacations like they do, but doing this will not reduce your sense of loneliness. We may unconsciously sacrifice financial security in our pursuit of emotional safety.
This is the first emotion that affects us: fear. The second emotion that affects us is overconfidence. None of us can predict the future, and we are not as smart as we think. In most cases, the higher the degree of overconfidence, the higher the cost of making mistakes.
Long-Term Capital Management (LTCM) is a hedge fund whose managers were very smart, including several Nobel Prize winners. These managers were once very confident that their investment choices would never result in daily losses exceeding $35 million. However, on a certain day in 1998, they lost $553 million, and the company eventually lost a total of $3 billion.
Alan Greenspan, who served as Chairman of the Federal Reserve for four terms, was long considered by the media and his followers to be a man who could do no wrong. However, the economic model that Greenspan had believed in for nearly 40 years led to the worst market disaster in the U.S. since the Great Depression of the 1930s. Later, he admitted to the U.S. Congress that when he realized the economic model he had been so confident in was flawed, he was devastated. As you can see, even these smart people are prone to making overconfidence errors, and we ordinary people are even more susceptible to this.
Of course, there is a third emotion: trusting others too easily. We always hope to find so-called masters who can predict the economic future so that we can prepare for it in advance. But reality is not like that. The future is uncertain, and no one knows what will happen. History does not help us predict the future. In fact, predicting the future correctly is extremely difficult. Even if someone correctly predicts a market change, it is just a matter of probability and should not be taken too seriously. You should know that no one can predict the future! The advice from relatives, friends, or even experts based on their own experiences and specialties is not necessarily correct, and it certainly is not necessarily suitable for you.
The author himself had a painful experience. In 1999, when tech stocks were booming, many people mortgaged their homes to invest in stocks. The author's brother-in-law worked for a high-tech company and often told the author how much potential tech development had and how much growth tech stocks would see. At first, the author resisted the impulse to invest, but after much persuasion from relatives and friends, he finally gave in and invested a large sum of money in what he believed to be a very promising tech stock. At the time, the stock had risen from $100 to $1,300. However, by March 2001, the stock had fallen below $25, and the author suffered huge losses. Afterward, the author framed the stock certificate and hung it on the wall, as a constant reminder not to make the same mistake again. He concluded that when a market attracts even the most rational and patient people, it is likely that the market has reached its peak, and that is when caution is necessary.
In July 2010, the famous market forecaster Robert Prechter predicted: "Because a major bull market is about to end, the Dow Jones Industrial Average will fall from its current level of 9,686.48 to below 1,000 points in the next five to six years." In early 2011, Yale's Robert Shiller predicted that the S&P 500 would rise from 1,280 points to 1,430 points in the next 10 years, with an average annual increase of 1.3%. In January 2011, experienced market observer Laszlo Birinyi predicted that the S&P index would close at 2,854 points on September 4, 2013. Three market forecasters, almost at the same time, published three completely different predictions, each of which was extreme. As investors, who should we believe? What should we do? The author tells us that all we need to do is ignore them!
Look at these emotional pitfalls—haven't we all experienced them? Fear, overconfidence, and blind trust in others can severely affect our rational judgment. It is these emotions that create the "behavior gap" in our decision-making, leading to unnecessary losses. Therefore, avoiding the influence of emotions is a key factor in making correct investment decisions.
Part Two
Now, this section is about how we can "customize" a financial decision that suits ourselves. First, make finance simple and avoid emotional interference. Let’s not forget why we care about financial security. We hope for happiness and want to provide a good life for our loved ones. Almost every financial decision is a life choice. Your financial goals could include retiring comfortably, going to college, funding your children's education, or traveling. Therefore, we should not spend excessive time searching for the perfect financial product; instead, we should think about what truly matters to us and adjust our use of funds according to these values.
For example, in the winter of 2011, a financial expert who had been following the financial markets for over 30 years was having a drink with his friend Gritty at a bar. Gritty was a veteran who worked in electronics. At the time, the bar's TV was showing a program where a government spokesperson was talking about oil prices. The spokesperson said that the rise in oil prices was due to the turmoil in Libya. Upon hearing this, Gritty said to the financial expert, "This guy is an idiot. Libya? Come on, we hardly import oil from Libya, so there must be another reason." After thinking about it, the financial expert agreed with Gritty, and the author also supported this view. "Although Libya is a net exporter of crude oil, its oil reserves rank only 17th in the world, and it has no direct trade exports with the U.S. So, investors' concerns about Libya halting oil exports seem to be exaggerated. But this tiny piece of information could trigger a large event, all driven by greed or fear — which can instantly lead us into a greater financial crisis."
Our plans can never cover all possibilities — and that’s not a big deal. You don’t have to choose the perfect investment strategy, you don’t have to save a specific amount, you don’t need to predict the return on investments precisely, and you don’t have to spend all day watching stock market analysis or frantically searching online for stock-picking tips. You don’t need the perfect plan that considers every possible scenario. Your financial decisions should align with your personal philosophy and worldview. The better you understand yourself, the higher your chances of investment success — meaning your investments will better align with your true life goals. Making cautious choices based on actual circumstances is the best way to help us achieve those goals.
Remember the rule: "Plans are no match for changes." We cannot predict the future. Therefore, when we make a long-term plan, we should shift our focus to what we can realistically achieve in the short term, say in the next three years. This helps us focus on what’s actually happening right now. By living in the moment, we can become aware of what’s happening around us and act according to what we observe. Action based on a realistic financial plan often leads to better returns. We need to keep planning the process — not the plan itself — to keep moving towards our goals and avoid falling into behavioral traps.
We must always keep in mind an unchanging investment law: If the potential returns from an investment are high, the risks are high as well. So, blindly pursuing high returns is not good for your assets. Even if you make very smart decisions, you cannot control the outcome. We often complain, but it doesn't help; we also do things that seem cost-saving but are actually not worth it. Therefore, when making decisions, be careful not to make money the sole priority; instead, incorporate your understanding of morality, wisdom, and common sense. You are responsible for your actions, but you still cannot control the outcome.
This is the first method to avoid emotional factors: Find what you really want, then make cautious choices based on actual circumstances, instead of blindly pursuing high profits. The second method is not to trust others blindly and to avoid falling into the trap of vague financial advice. Understand that personal finance is a personal matter, and the focus should be on the individual, not the finance. Therefore, financial planning should be "customized."
There is no such thing as the "best" investment strategy. Everyone’s situation is different, so the investment choices also vary. For example, some people want to find a hot stock but have not yet purchased life or disability insurance; others want to find the highest interest savings account but carry a credit card debt with 18% interest. This is strange — why not use the savings to pay off part of the credit card balance? Because that would effectively earn you an 18% return on your money.
Viewing work as a tool to make money and investment as a tool to protect your wealth can also be very helpful. Always remember, you have zero control over market fluctuations, but you at least have some control over your own actions. So, focus on your personal financial issues and don’t worry about global economic changes. We can do things that will actually change our financial situation — work harder, try to save more money, or find ways to earn more.
The author has a friend who suffered from depression from his twenties. Later, he mortgaged his house to see a psychologist. Five years later, feeling sufficiently recovered, he quit what he thought was a hopeless job and began writing. Now, his books have sold over 500,000 copies, and he has published numerous articles. He said that seeing a psychologist was the most successful financial investment of his life.
The question everyone needs to think about is how to combine the information and ideas you gather with your actual circumstances. Financial advice that is suitable for you might be disastrous for your neighbor. Therefore, do not follow others' generalized advice, including that from professional advisors and financial planners, and certainly do not believe in market predictions. You need to consider your own situation, and based on your own experience, choose the investment approach that suits you.
Now that we’ve talked about not blindly trusting others, let’s move on to the last point: don’t be overconfident or act out of habit. Make dynamic adjustments based on real changes. We can design our investment plans according to our understanding of the current financial market trends and the goals we hope to achieve in the next few years. If things change, we can adjust accordingly. If we need to seek others’ opinions, we should turn to people who know us and whom we trust — not a stranger on a TV show.
Don’t think about finding the next Apple Inc., because the probability of picking the next Apple or the next Google is almost zero. Choosing stocks based on past growth to predict future growth is like using the result of the last coin toss (heads) to predict whether the next toss will also be heads — it’s meaningless.
Find your focus because our time and energy are limited, and they must be used wisely. A simple rule to follow: Focus your attention on things that are important to you and that you can influence. You need to have a basic understanding of your investments, not blindly follow others, and don’t make decisions based solely on limited experience. What we need is to plan for our financial future, find financial balance, and not just chase the highest returns. The process of seeking balance will be different for each individual.
For example, a female client in her later years called the author one day because she was very concerned about the situation in Lebanon and wondered whether the events there would affect her investments. The author told her two facts: First, the situation in Lebanon will not significantly impact your life; and second, there’s nothing you can do to influence the situation in Lebanon. Such examples are common in real life. People often worry about things they can’t control. So, focus on things that are important to you and that you can influence, and forget about the rest.
We need to periodically review our investment portfolios to ensure they align with our goals. Habit and familiarity often cause us to forget about risks. Investment decisions should be based on what we understand, not based on feelings. We can’t eliminate all emotional influences when making decisions, but we can strive to ensure that knowledge occupies a greater space in our financial decisions. Investing is like life, forcing us to make decisions in the fog of uncertainty. We cannot always be right or wrong. We need to make decisions based on available information, observe the outcomes, incorporate new information, adjust our course, and repeat the process. This is the third method: Don't be overconfident or act out of habit. Instead, make dynamic adjustments based on real changes.
Summary
This is the essence of what the book teaches us. Let’s review:
The author believes that emotional influences often affect investment decisions. What makes investing more effective is not market conditions, but our own decisions. To overcome the influence of emotions:
- Find what you really want, then make cautious choices based on actual circumstances, instead of blindly pursuing high profits.
- Don’t blindly trust others, and avoid falling into the trap of vague financial advice.
- Don’t be overconfident or act out of habit, but make dynamic adjustments based on real changes.
In conclusion, slow and steady investing, and striving to make decisions that are "customized" to our needs, is the most important aspect of making correct financial decisions.
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