Title: "The Behavior Gap: Simple Ways to Stop Doing Dumb Things With Money"
Author: Carl Richards
Publisher: Portfolio Penguin, 2012; 192 pages; $24.95
The concept that individual economic behavior is not nearly so rational as economists once thought is not nearly so revolutionary as it once was.
But understanding that our personal financial decision-making is flawed, and solving for that, are two different things. Financial planner and New York Times money blogger Carl Richards aims to help readers do the latter in his new book, "The Behavior Gap: Simple Ways to Stop Doing Dumb Things With Money."
In Richards’ system (and by system I mean series of bizarrely insightful and useful Sharpie sketches illustrating the equally bizarre ways individuals commonly think about their financial lives and investments on napkins), the behavior gap refers to that fundamental truth of the markets: that investor performance is significantly worse, on average, than investment performance.
Investment portfolios that are actively traded do much worse in terms of long-term returns than if the funds had been allowed to simply sit idle for the same period of time in a single investment.
Richards began using "the behavior gap" to apply to this specific issue, but over the years found himself creating numerous sketches of all sorts of behavior gaps, which he now shares in the book to "describe all kinds of situations where our behavior leads us to subpar results."
In "The Behavior Gap," Richards aims to help us understand what is actually driving our actions in behavior-gap scenarios — mostly fear and greed — and then offers a number of simple, yet powerful, tweaks to the way we think and act about our personal finances to help us mind (and cure) the gap.
Here’s a sampling of some of the ways Richards suggests we rethink our approach to investment decision-making:
1. Lengthen your definition of the past. Richards devotes a fitting chunk of time to the truism that we tend to buy stocks, real estate, gold, etc., when they are at their most expensive, at the top of the market, and sell at or near the bottom, once they’ve already begun their decline.
That’s because, he says, our memories are entirely too short-term, so that we tend to make our investment moves based on the recollection of our brother’s home selling for a massive profit or loss a couple of weeks ago, rather than on the longer-term memories of the time we went all in on tech stocks and lost scads of cash in the dot-com bust.
2. There is no "best investment" — there are only "best decisions." Richards advises that life, the markets and specific stocks are largely uncertain and unpredictable. Their past performance had little or no relationship or predictive power of what will happen in the future, and it is not even possible to insure and protect ourselves from all the life crises and changes that might befall us, to the extent the financial services industry would have us believe we can.
In fact, Richards vividly argues with examples from his own life, many of the events we might think of as calamitous can turn out to be very lucky and fortunate in retrospect (e.g., the time he got fired from his job for insisting on Sundays off, only to end up with a vastly better career, including a New York Times blog).
Accordingly, Richards says we should do the sometimes daunting work of getting uber-clear about what matters to us, and what we want for our lives, then make a plan for creating that, only deciding at the end of the process which specific investments to leverage as part of that plan.
Then, we should, he says, relax and be free of anxiety about the outcomes of our investments because, again, over time, they will perform better if we simply let them be. Our ultimate objective should be to make wise decisions in accordance with our plan, rather than to look for the next Apple or Microsoft (a fool’s errand, at best).
3. Be an investor, not a collector. Those who scour those Fortune and Money magazine lists of the best stocks, funds, companies and so forth, in an effort to buy the "best" investment are, in Richards’ taxonomy, "collectors," not investors. Collectors buy some shares of this and some of that, like baseball card aficionados, rather than being committed to a strategic, long-term plan.
Additionally, collectors are wont, in Richards’ experience, to focus on finding a winning investment, to the detriment of the overall plan, often ignoring the glaring holes and pitfalls in their personal finances, like high-interest credit card debt.
4. Plan your life, not your finances. In several brief, profound sections of the book, Richards proposes some holistic questions to consider as you try to set up a simple life plan — a happiness plan, really — which drives your financial decision-making. How would you live your life if you had financial security? What would you do if you were told you had only five years to live, but wouldn’t feel sick for those years?
Whether numbers make you nauseous or all tingly inside, "The Behavior Gap" is for you, especially if you want to limit the time and anxiety you expend on your personal finances while putting your money into service to help you create the life you really want to live.