Why Investors Underperform: Understanding the Behavior Gap
Every year, Morningstar publishes its Mind the Gap study, and every year the results are the same: investors earn significantly less than the investments they own. The reason isn’t fees, taxes, or bad investment selection. It’s behavior.
This guide examines why investors consistently underperform and what financial advisors can do to close the behavior gap for their clients.
The Behavior Gap Explained
The behavior gap is the difference between investment returns (what an investment earns) and investor returns (what investors actually earn after their buy and sell decisions). It exists because investors consistently buy after performance has risen and sell after it has fallen.
The behavior gap is alive and well, and it’s not getting smaller. Despite increased awareness of behavioral finance, investors continue to make the same timing errors decade after decade.
Top Reasons Investors Underperform
Chasing Performance
Investors are drawn to recent winners. When an asset class or fund has performed well, money flows in — usually near the peak. When performance reverts to the mean, these late arrivals experience the full decline without having participated in the gains.
Learn why chasing performance is fueled by hope and rarely ends well.
Panic Selling
During market downturns, fear drives investors to sell at exactly the wrong time. They lock in losses, miss the subsequent recovery, and often buy back in only after prices have risen significantly.
Overconfidence and Excessive Trading
Many investors believe they can time the market. Each trade incurs costs and introduces timing risk. The evidence is clear: more trading leads to worse outcomes.
Ignoring the Long Term
Investors who focus on short-term market movements make decisions based on noise rather than fundamentals. Myopic investing — focusing on the short term — is one of the most expensive biases an investor can have.
How Advisors Help Close the Gap
The most valuable thing a financial advisor does isn’t picking investments — it’s preventing clients from making behavioral errors. Here’s how:
- Pre-commitment strategies: Document investment plans before markets move
- Behavioral coaching: Coach clients through emotional periods
- Regular communication: Proactive outreach during volatility, not reactive
- Education: Help clients understand cognitive biases that drive poor decisions
Frequently Asked Questions
What is the behavior gap?
The behavior gap is the difference between the returns an investment generates and the returns investors actually earn. It exists because investors buy and sell at the wrong times — buying high and selling low.
How large is the behavior gap?
Studies from Morningstar and Dalbar consistently show investors underperforming their investments by 1-3% annually. Over a 30-year investment horizon, this compounds into hundreds of thousands of dollars.
Can the behavior gap be eliminated?
While it can’t be fully eliminated, it can be significantly reduced through behavioral coaching, systematic investment processes, and pre-commitment strategies. Learn about how advisors help clients avoid costly mistakes.
Keep Learning
Explore more articles on investment mistakes, cognitive biases, and market volatility throughout this site.