Onecommon query I keep facing repeatedly by the existing investors in trying to compare their portfolio or investment with a current performing investment portfolio. Of course, one should be aware of how their investments are doing vis-à-vis a benchmark and that could be another portfolio. But it’s when we compare with a wrong benchmark/portfolio and/or incorrect timelines, lead to wrong judgments. The conclusions henceforth could potentially result in poor decisions.

Behaviour gap in investing has become commonplace in recent years, thanks to the availability of abundant information. It refers to the difference between the returns an investment could have achieved and the actual returns an average investor achieves. This could be due to their own behavioral and emotional decisions. It’s essentially the cost or penalty that investors pay for letting their psychology override their rationale.

It boils down to two returns. Investment Return: The theoretical return of an asset (eg. Stock, commodity, fund, etc. or even the overall market) over a specific period if simply bought and held without any trading. This is what we get to see the published data about the market indices, prices of commodities, return on the model portfolio or funds.

Investor Return: The actual return achieved by the average investor in that same asset or fund/market, factoring in their individual decisions to buy, sell, switch or other timing actions in the market.

Studies have consistently found that gap i.e., investment return – investor return is negative i.e., investors on average significantly underperformed their very investments or funds they hold. The observations have revealed that investors sabotage their own returns primarily through emotionally-driven actions, the key causes for this gap.

Panic selling: selling investments during market drawdowns out of fear, realising the notional losses and failing to participate in the subsequent recovery.

Performance Chasing (FOMO): Fear Of Missing Out on a rally or euphoria around an asset, investment, etc. leads to knee-jerk reactions to ill-timed entries or exposures. Buying assets after they have already experienced significant price increases, often leading to buying near the peak just before the correction.

Overconfidence & Market Timing: Believing one can predict market movements and frequently buying/selling to “beat the market” often incurring higher transaction costs and mistiming entries/exits.

Loss Aversion: Feeling the pain of loss more acutely than the pleasure of an equivalent gain. This leads to holding onto losing investments too long (hoping to break even), even at times averaging it (buying more of it) and selling winning investments too early (lock-in gains)

Recency bias: We tend to overweigh recent events or trends and extrapolate them indefinitely into the future (NFT, meme stock, etc.) leading to wrong assumptions.

Overtrading: Excessive transactions (buy/sell) driven by emotions or at times boredom, increases costs (transactional and tax) while often mistiming the market.

Studies have found that behavior gap is single biggest cost far exceeding fees for most investors. While it’s difficult to remain stoic, super-rational and retain the long-term perspective all the times is unnatural to humans, we could address this biggest drag through some workable steps.

Know thyself: Understand your own biases as an investor, recognise them and so could overcome. Resisting their influence wouldn’t help things.

Limit information intake: In this information age, access to information is easy and almost free. Avoid consuming sensational financial media and restrict checking the portfolio constantly, avoiding rash or irrational decisions. Seek professional help: A ‘fee’ paid to a professional is not a cost but a transfer of decision making, analysis time and most importantly a good financial advisor acts a behavioral coach helping you to bring back to the original path, particularly during trying times.

(The author is a partner at “Wealocity Analytics”, a SEBI registered Research Analyst and could be reached at [email protected])