Special to the Globe and Mail
Published October 14, 2015

By Tom Bradley

At an investment conference I attended recently, there was a stream of smart, energetic and super-rigorous portfolio managers trotting to the podium to talk about their best stock ideas. Essentially, they’d identified inefficiencies in the market and were showing how these mispricings will lead to oversized profits.

As I listened, I couldn’t help but think about a persistent inefficiency that’s staring asset managers and investment dealers in the face.

It’s the gap between how the markets do (bonds, stocks, funds, ETFs and other products) and how individual investors do. Study after study shows that individual investors do considerably worse than the overall markets.

Carl Richards, a New York Times columnist and investment educator, dubbed it the Behavior Gap.

Mind the gap

I recently saw confirmation of the behavior gap in a JPMorgan presentation. Using data from Dalbar, a chart showed a 20-year annualized return of 8.7 per cent a year for an indexed portfolio made up of 60 per cent U.S. stocks (S&P 500) and 40 per cent bonds. On the same chart, it showed the average investor earning just 2.5 per cent.

Talk about a gap. You could drive a truck through it. And the thing about this inefficiency is that it’s not up for debate. There are no assumptions that, if changed, would make it go away. For all of its brain power, innovation and profit, the investment industry has whiffed on the biggest and most sustainable inefficiency there is.

Wide and persistent

Why haven’t market forces and consumer preferences narrowed this performance gap?

Well, first of all, there’s a serious mismatch between capital markets and investors. Markets are complex, unpredictable and, at times, volatile. Investors are busy, generally unknowledgeable and in constant pursuit of certainty. As a result, investors have an innate tendency to buy when things are rosy (high), and sell when there’s nary a positive word (low).

This “buy high, sell low” pattern is reinforced by the wealth-management industry and the news media, which consistently exhibit pro-cyclical behavior. Gold is promoted when the price is high, not low. Tech funds and energy partnerships are more likely to be offered in good times. Guaranteed or low-volatility products are advertised when markets are down.

The studies also point out that investors trade too much, and certainly excessive fees are part of the gap.

Working with clients, I’ve observed another reason. Many investors have their portfolio in multiple pots, which invariably causes slippage.

Household assets are not well co-ordinated, so the overall asset mix is unclear and there’s too much money lying around doing nothing. Of all the bull markets I’ve experienced, this has been the worst for Canadians being underinvested and not fully participating.

A gap analysis

The wealth management industry has been slow to promote better client behavior, but there are things you can do to improve long-term returns.

The first step is to determine whether you have a gap. You should ask your investment manager or adviser for a complete review of your returns, with comparisons to a simple balanced or indexed portfolio.

The next step is to stop overpaying. More specifically, stop paying for things you’re not getting or don’t need – advice you didn’t receive, active fees for passive management or multiple people providing the same thing.

Part of better cost management is understanding the low-cost alternatives, such as ETFs, low-cost mutual funds, discount brokers and robo-advisers, all of which could play a role in your portfolio.

It’s imperative that you consider all your financial assets when determining an asset mix. Agonizing over your registered retirement savings plan without considering how it fits with the other pots is counterproductive. You want to avoid the slippage that so many investors experience.

And finally, the biggest cause of the behavior gap is having the wrong “default” position. Most investors, if they’re busy, or worried or unhappy with their adviser, leave money in the bank. Their do-nothing option is a savings account.

For investors who are worried about their retirement income, however, the default position for every investment dollar should be their long-term asset mix, not cash.

It’s not rocket science. With a little analysis of your situation, you’ll identify more inefficiencies than the hedge fund managers I listened to.

And you don’t need to be smart, energetic and super-rigorous.