The Most Important thing in Investing: Behavior

If you are going to keep one image about investing in your mind, this should be it:

Based on the chart* above if you had put $1,000 into the stock market on January 1, 1991 and kept it there till December 31, 2010 you would have made a healthy 9.14% annual return, leaving you with about $5,750.

Of course, no one actually invests that way.  People move money into the market, they take it out, they add more as they go, or they just sit on the sidelines for a while. When you look at what people who had invested in the stock market actually made over that same time frame it’s a meager 3.85%, meaning that you would have only $2,120 after 20 years. That’s a huge difference.

Why the Difference?

The biggest driver of that difference is people’s behavior. Basically, instead of buying low and selling high, people tend to do exactly the opposite. When the market is doing really well it’s only natural to get swept up in the excitement of it all. And when things aren’t going well, our tendency is to want to sell everything and walk away. And that is just what most people do.

Carl Richards has a website called the “behavior gap” that does a marvelous job of talking about this and other interesting behavioral issues around investing.

So Whose Fault Is It?

The investment industry will have you believe it’s the investors’ fault. We can’t control when investors put money in or take it out, or their emotions. Perhaps. But it’s also true that the industry hasn’t tried to do much about it. Investment professionals, articles, and reporters tend to focus on the same old questions. Things like “what should I invest in?”, “how much is it costing me?”, and “what should my asset allocation be?” I’m not saying those questions aren’t important, but it turns out that they are far less important to your success than figuring out how to keep people from buying high and selling low.

What is To Be Done?

Most importantly, this doesn’t mean you shouldn’t invest. It does mean that when you start to invest you need to be aware ahead of time of the behavior gap. You will need to fight the fear and exuberance that comes with the ups and downs of the market. Don’t follow it every day, and don’t get swept up in what your neighbors are doing.

How GoalMine Helps

At GoalMine, we are trying to help you manage behaviors that will lead to investing success. We are building in tools and services into our website to help you deal head on with some of the behavioral issues around investing. For example:

• By focusing on your goals rather than on what other people are doing or what the stock market is doing, GoalMine gets you thinking about what really matters.
• In your GoalMine account we show you how much money (in dollars, not percentages) your investments have made or lost since that is what you should be focused on—not theoretical percentages.
• We are building in tools like our upcoming Instant Investing mobile application, which will allow you to easily add money to your investment account from a mobile phone with as little as $1 at a time, and for no fee.

We have lots more things planned along these lines and would love any additional ideas that you have for us.

*Data for this chart is taken from the Dalbar Quantitative Analysis of Investing Behavior Study.