The Behaviour Gap: Book summary

The ‘Behaviour Gap’ is a simple and profound book. It can change your lives. You can read more about the philosophy here.

These are my notes from the book.

Introduction

Life is unpredictable. Most plans are useless. We cannot be perfect. But personal finance is simple. But it is not easy. We have to remember this:

  • Stop chasing fantasies
  • Take sensible steps to protect yourselves, but remember you can never think of everything
  • We want to be happy and fulfilled, not rich. We think that being rich is the route. But we have define what rich means to us personally, not what rich means to Warren Buffet or Bill Gates. You have to decide what you really want. That can take time. Take the time to make the decision.
  • You have to make sensible decisions and leave the outcome to God, or whatever.
  • Luck is a important factor in life. We are not in charge of everything. Therefore, relax.
  • You have to trust yourself, what you really want. You have to be true to yourself. Then, whatever happens is for the best.

We don’t beat the market, the market beats us

The returns that investors earn over time are lower than the returns of the average investment. This is the behaviour gap.

This is because we buy high and sell low. This is because we don’t have a plan. A plan that makes sense.

The higher the increase in the price of an asset class, the riskier it is.

However we want to buy things that have gone up in price and not selling them. This is because we hate loss more than we like gain. We are fearful when everybody is fearful and greedy when everybody is greedy and not being greedy when others are fearful and fearful when others are greedy.

Investments do not make mistakes. Investors do. We have control till we actually invest in something. Therefore you need to make the decision carefully.

Some ways to close the behaviour gap are as follows:

Remember that our natural tendency is to avoid pain and seek pleasure

We are terrible at predicting the future. Our expectations are too optimistic or pessimistic as compared to reality. This leads to boom and bust cycles. This is because  we do not learn from the past. We need to lengthen our definition of the past. A little experience can be dangerous. We think investing is easy especially if the stock market or the housing market has been kind to us recently. But it never is. It is simple if you can make a sensible plan and don’t chase fantasies. But it is never easy.

Fear and greed are two emotions that play a major role in financial matters. If fear is the main emotion, then take less risk. We might think that greed is our main emotion and might want to take more risk. If so, you have to prepared to see your stock market investments lose 50%, and still be greedy and not fearful. Warren Buffet can do that, but can you?

Overconfidence leads us to take more risk than what we can actually take. The OC (over-confidence) questionnaire is a good deterrent:

  1. If I make this change and I am right, what impact will it have on my life?
  2. What impact will it have if I’m wrong?
  3. Have I been wrong before?

Before you invest your hard earned money, ask yourself whether you are doing it because you think it is a good investment or are you relying on a greater fool to come along and buy it at a higher price?

You cannot buy high and sell low and hope to become financially independent. The best way to avoid doing this for the most of us is to set up a decent financial investment plan(50% stocks, 50% bonds is probably the best for most of us). Follow a process like this;

  • Have a real plan
  • Find investments to populate the plan
  • Admit there is a problem
  • Face that cash is a not a solution to the crisis
  • Develop a checklist of questions to ask before you make major financial decisions?
  1. Is this part of a plan?
  2. Fear or greed?
  3. Following other people? Are they good role models
  • Take your time: at least 24 hours
  • Incorporate new information slowly
  • Focus on your own behaviour, not the market’s behaviour

The perfect investment

Important questions to ask?

  1. How much can you reasonably save?
  2. What rate of return you will earn?
  3. How much do you need?
  4. And when will you need it?

There is no such thing as a best investment. It all depends on the situation.

Don’t collect investments. You are not a collector. Each investment that you make has to make sense when you consider the whole picture.

Past performance has little predictive value. Expenses and fees are important. Focus on finding a low-cost investment that you can stick with over the long haul.

Do not look for the next hot stock. Do not try to invest in the next hot stock. The hotter the investment, the greater the risk. If you do this, you will lose sight of your plans and goals and will end up losing a lot

Sometimes good decisions will lead to bad results and bad decisions will lead to good results. In the long run however good results are got by only making good decisions.

Ignore advice, make fun of forecasts

Most of the advice we give and get is useless or worse. People give advice based on their own perceptions and not the reality of your life.

You have to remember that personal finance is more personal that it is finance. You have see how any advice applies to you before you make important decisions about your money.

No one knows what the future holds. If people make enough guesses, they are bound to get at least a few of them right. Hence do not believe or act on any predictions that people make.

Advice and forecasts are distractions from the goal: getting to know ourselves, our goals making choices aligned with those goals and adapting to surprises along the way.

We can design our portfolios to suit our best current understanding of how financial markets tend to work and what we want to achieve over the coming years. If things change we can adapt.

You don’t base your portfolio on what somebody else does( institution, investor, individual). You have to base it on your goals, risk tolerance and what you want to do with your life. Your life is not the same as Harvard’s endowments or Warren Buffet’s Berkshire. You are you.

Financial life planning

Memorable experiences with people you love are a great source of happiness. Use that goal as the baseline for your decision-making. Then you can easily focus on the things that matter the most: working hard, saving a lot and behaving wisely.

Once you can afford food, shelter and healthcare, have some hobbies, a social life and some travel, more money is not going to make you more happy.

Life goals are more important than financial goals. Then financial decisions become life decisions, which they really are.

Happiness is not linked to money. It decreases if you try to keep up with the Joneses. It increases with great relationships and memorable experiences. It decreases if we spend our time looking for it. Happiness come easiest when we are so busy with our lives that we forget to look for it. Ak yourself what makes you happy? you will find it is personal relationships, fun and love and not money.

Find out what sustains you? What do you need to live? Who are you? What do you want? Then you can stop wasting your life energy and your money and stuff that does not matter to you – and start making financial decisions that will get you to your true goals.

Life planning is to discover our deepest and most profound goals and all financial planning is life planning. One way to do this is to ask three questions:

  1. First, imagine you are financially secure. How would you live your life? What would you change?
  2. Next, imagine a doctor tells you that you only have five to ten years to live- but you won’t feel sick. What will you do in the time remaining?
  3. Finally, this time the doctor says you have 24 hours. What feelings arise? What did you miss?

Consider your answers to these questions when you make financial questions. You are more likely to make choices that better show your values.

The urgent important matrix is another thing we can use to prioritize.

Too much information

There is a lot of information that comes out daily- how the economy is doing, how certain events are going to affect your financial life, etc. You do not have control over these things. Yes, you need to pay attention to these things but don’t change your plan because of it unless it is really needed, which is extremely rare and would not happen usually.

Do not think that some so-called “secret” information is secret. It is very unlikely.

When everybody is buying something, it is probably expensive and therefore risky to own. When everybody is selling something, it is probably cheap, and therefore potentially appealing.

You should not make investment decisions on what you see at the newstand. You will most likely make mistakes.

Build a plan that you will follow or commit yourself to a plan that somebody else manages for you.

Ignore(almost everything). The more you follow the market, the less long-term wealth you will have. There is a lot of information out there. But 99.99% of it is noise, not worthwhile. Free your mind of it. Have a media fast. Follow your plan. Stay the course. And you will be successful.

The past is gone. Learn from it. Don’t regret it. The future is yet to come. Plan for it, but don’t worry. Today is here. Live it as best you can.

Plans are worthless

Plans are worthless. Because they are based on assumptions over a long period. The assumptions could easy be wrong and hence your financial plan too. We do not have the information when we start. It is not based on fact. It is based on assumptions( which are made about how the past behaved). But when man proposes, God disposes and all this could easily fall to pieces.

But we have to plan. We have to make assumptions, even though you may know it could be wrong. Then you adapt with time.

Then live now. Focus on the next three years. What are going to do in terms of spending, saving, investing, living. This is all we can do. Correct yourself if you think you are going the wrong way.

Investment risk increases with time. The difference between a 5% return and 7% return over 30 years can be enormous. You have to make course corrections and that may help you to reach the destination.

Do not worry about global events. No one really knows what these events really means.

Remember:

  • These are not problems now.
  • Focus on your personal economy and do not worry about the global economy.
  • Higher returns are not the key to meeting your financial goals or your life goals.
  • Think of saving, spending and investing in a simple and effective way.
  • Remember you have no control over what the market does.

Money does not mean anything. It is a tool to help us reach our goals. Goals, not pseudo goals( like picking the right investment) or fake goals(keeping with the Joneses). Focus on what really matters to you.  Then the financial goals will fall into place.

Limit your attention to things that meet two criteria:

  1. They matter to you.
  2. You can influence them

Feelings

Feelings can be expensive. You will make a lot of mistakes if you are emotionally attached to your investments.

  • You need to know what you own, and why you own it.
  • You need to satisfy the overnight test: would you buy it again, if I sold it overnight at the current price?
  • Does it play a role in your portfolio? What role?
  • If you can’t answer he above questions, sell it.

Do not anchor yourself to an investment price.

If you want to make a change to your investment portfolio, it should be based on a plan, not feelings? Mostly we do not need to make any change. In the rare situation when you should make a change ask yourself two questions:

  • If I act on this new information and it turns out to be right
  • If I act on this new information and it turns out to be wrong, what impact will it have?

You’re responsible for your behaviour( but you can’t control the results)

  • If it is too good to be true, it probably is not true.
  • If the potential returns are high, the risk is also high
  • Conflicts of interest are always there when you pay for advice. It manifests in different forms.
  • Positive change requires hard work, patience and discrimination. Not just hope.
  • Investing is not entertainment. Stock picking, day-trading and market timing are hazardous to your wealth.
  • Do not whine. You are responsible for your own financial situation.
  • Do not be penny wise and pound foolish.
  • Even when you make wise decisions, you have no control over the consequences.

When we talk about money

Talking about money is difficult. There is a lot of baggage. But if we can have meaningful conversations about  money it can lead to really quality decisions. Our views and expectations of money are different from others. Recognise that. What worries and what comforts us may not make financial sense and yet be the right thing for us to do. Talking with kids about money needs to be frank and we need to explain to them that money is not unlimited; and that they should spend the money on what really mattered, and avoid buying things that are really not important.

Simple. Not easy

Simple solutions are the most effective. We often resist simple solutions because they need us to change our behaviour. The simple options need patience, discipline and hard work. It requires us to do simple things over and over for many years. The more you crave instant gratification, the more problems you will have. Budgets are important. You need to save money. Some ways to do it are:

  1. Try a 3 day or a 30 day waiting period before you buy something.
  2. Go on a multiweek buying fast where you don’t buy anything except necessities
  3. Track your spending
  4. Put a price tag to your goals.
  5. take taxes into account when you buy something.
  6. Think about what you’d earn if you invested the money instead of spending it.

These are simple ideas but they are not easy.

The secret is to spend less than you earn, setting some money aside for a rainy day, paying down debt and steering clear of large losses. Simple but not easy.

  • Slow and steady wins the race and not finding the next Google.
  • Slow and steady avoids large losses
  • Slow and steady means you can have a life and turn off all the noise of Wall Street.
  • Slow and steady know that the goal of investing is to accumulate the capital you need to fund your most important goals.
  • Slow and steady is simple but not easy. You won’t get rich quick and you won’t get poorer quick.
  • Slow and steady is short term boring. But it is long term exciting.

Conclusion

  • Learn from past mistakes and let it go.
  • Know where you want to go.
  • Make a decision to help you go there.
  • Make corrections along the way, if needed
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2 thoughts on “The Behaviour Gap: Book summary

  1. mrwoodpecker says:

    Very interesting post.
    Especially the chapters on “Life planning” and “Too much information” – they confirm similar thoughts that crossed my mind recently.
    Difficulty is to keep up with the theoretical insights in everyday life.

    Cheers,
    woodpecker

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