“You can’t buy a game.” Even though I know my brother-in-law is right, it hasn’t stopped me from trying. If you don’t know what I am talking about, you are obviously not a golfer.
Golf is a hard game to master. It requires lots of practice. My brother-in-law, a former teaching and touring pro, told me I would need to hit 300 balls a day if I wanted to get good. I have neither the desire nor discipline to do that. So, I keep buying the latest and greatest golf equipment in hopes that it will make up for the deficiencies in my swing or, as a golfer would say, “the gaps in my game.”
It seems to me that many investors have a similar problem – They try to make up for deficiencies in their savings by employing investment strategies they hope will beat the market. And this is not just an issue for individual investors. A large percentage of public pension plan administrators are hoping that alternative investments will provide the extra returns needed to make up for their funding gaps. But, according to Greg Mennis, director of Pew Research Center's retirement systems project, “…policymakers cannot count on investment returns to close the pension funding gap.” Both individuals and institutions need to realize that only in Lake Wobegon would this be possible because that’s the only place where all the investors are “above average.” In the real world “…the average investor underperforms the average investments,” according to Carl Richards the author of The Behavior Gap.
This last paragraph illustrates an important point. Just as most golfers have multiple flaws in their swings, so do most investors have multiple deficiencies in their retirement plans. They have funding gaps caused by saving shortfalls which, unfortunately, aren’t often compensated for by excess returns. More often than not they are exacerbated by a return underperformance flaw which Richards calls the behavior gap. To explain this flaw he “…started drawing a sketch on whiteboards during meetings. The sketch has a tall bar labeled investment return, a shorter bar labeled investor return, and the space difference labeled behavior gap.” The gap is a result of the quirkiness of the human brain. "It's not that we're dumb. We're wired to avoid pain and pursue pleasure and security. It feels right to sell when everyone around us is scared and buy when everyone feels great. It may feel right - but it's not rational."
Richards didn’t discover this phenomenon, which has been well known for decades, but his sketch and the publicity it received did increase the awareness of the issue. And that is important because it helps investors and their advisors to focus on behaviors they can control instead of on returns that they cannot. That’s why a couple of decades ago I told an employer, “I think DFA offers the best mutual funds for your 401(k), but your employees would be better off if they had mediocre funds and behaved wisely, than if they had the best funds and behaved poorly.” Mr. Richards said something similar in his book, “…investors could just own an average fund, and if they behave correctly, they will outperform 99% of their peers… So, if I could just get clients to behave correctly, I could…close [their] behavior gap.”
While most investors think my job is to eliminate uncertainty, I understand. As Richards explains “…[my] job is to help people make massively important decisions under conditions of irreducible uncertainty.” And to be effective at my job I ask the same question he does, “…why keep wasting time on returns when there are so many other questions we can ask that will make a difference?” Things like how to shrink the funding gap by saving more or how to reduce the behavior gap by trading less.
There are no shortcuts in golf or investing. You can’t count on new clubs or exotic investments to fill the gaps in your game. However, since I am still irrationally trying to buy a golf game, I understand why investors feel like they can. But, as an advisor, I know that it isn’t rational. “You can’t buy a game.”
How We Help Fill The Gaps
For 401(k) plans we can help by designing plans where the default options are good options. For our individual clients we offer eMoney’s financial software for free. It not only helps eliminate the savings and behavior gaps but also the management gaps in your personal finances. It aggregates, organizes, and analyzes all your financial data so we can help you may wise informed choices about ownerships, beneficiaries, taxes, and much more.