Investment Returns vs. Investor Returns

This week, I want to make an important but relatively narrow point about investing.

This is going to sound self-evident or obvious, but most people don’t understand it.

The point I want to make is this: There’s a difference between investment returns and investor returns… and only one of them matters.

Let me explain.

Imagine you open the newspaper, and there’s an ad for a mutual fund. The ad says that investment has returned 10% a year for 10 years.

That is the investment return: 10% a year for 10 years.

Now, let’s talk about investor returns.

If you put your money into that investment at the beginning of the 10 year period, and you left it there for the whole 10 years—didn't add any, didn't take any out, just left it there—what would your return have been?

And no, this is not a trick question.

Ding ding ding: That’s right! Your return would have been as advertised: 10% a year for 10 years.

But here’s the catch: No one invests that way!

No one buys long-term investments and holds them for the long term.

On average, we only hold long-term investments for two to three years, and then we get distracted by the next hot investment.

So while the investment, in this case, does 10% per year, we almost never earn that return because we don’t own the investment long enough. We’re too busy switching in and out of different investments. The return happened… we just weren’t there to get it.

And the only reason for that is our own behavior.

We think the job of any self-respecting investor is to constantly be searching for the best investment.

That makes sense and sounds reasonable enough.

But that well-intentioned behavior consistently leads us to buy investments that have just done well and to sell investments that have recently done poorly.

In other words, the well-intentioned search for the best investment leads us to buy high and sell low, over and over again.

And it's that repeated behavior that leads to the difference between investment returns and investor returns. In other words… The Behavior Gap.

Once you see this, it’s hard to unsee it.

And that’s my hope. My hope is that this will be seared into your brain, and you won’t be able to forget it.

Stop searching for the best investment and, instead, focus on being the best investor.

You’ll save a lot of money, and a lot of heartache, if you do.