Carl Richards wrote a blog, a book and a New York Times column for many years. He also did the illustrations for my latest book, How I Invest My Money.

Carl has referred to his body of work as the Behavior Gap. In case you’re wondering what that is, the behavior gap is the difference between the investment results of a given fund versus the actual results received by the fund’s investors.

It seems strange that there would be any gap at all until you think about all of the reasons that make people buy and sell an investment in the first place. Then it makes perfect sense that this gap should (and does) exist, both in theory and in the real world.

The Gap

If a fund has a track record of producing 9% average annualized returns over the course of ten years, you can picture the volatility it took for those returns to be produced. One year up 23%, the next year up 4%, the following year up 12%, the year after that down 8%, then back up 11%, etc. You don’t have to know that much about human nature to understand that most of the money that came into the fund probably arrived shortly after the +23 year. And you already know during which year the most money probably flowed out. This is why there’s a difference between the dollar weighted returns that investors in the aggregate experience versus the time weighted returns that get recorded by Morningstar as the fund’s “track record.” And this difference, my friends, is the behavior gap.

Investors have a tendency to want to back winners and run from losers, because we are all human and this is innate. It’s within our DNA to want to do this, even if we don’t consciously realize it. A fund that has just declined (or underperformed) looks like it should be abandoned. A fund that has just posted huge gains and outperformed its peers looks like an obvious buy.

Make a habit of reacting to performance this way and you’re sure to lose. The market doesn’t reward you for reacting in comfortable ways. It rewards those who can endure discomfort or do the things that others simply cannot bring themselves to do. Like sit tight in the face of volatility. Or run toward the sight of a disaster, wallet in hand ready to buy. Or ignore a bubble regardless of how rich your neighbor is getting. These things are nearly impossible to do, which is why you get rewarded for doing them.

What Never Changes

Of course, nothing in the markets is ever this simple. What is simple is that there is absolutely no evidence that winning funds persist and remain winning funds forever. There is also no evidence that anyone can reliably select them in advance or determine the right time to deselect them and sell out. There is, however, plenty of evidence for the fact that buying high and selling low, repeatedly - almost systemically - is a losing strategy. No one would logically do this. But it’s our emotions that engender these behaviors, therefore, it is our emotions we need to focus on the most.

Carl figured this out early and made a career out of teaching it to both investors and financial advisors. I met him early enough in my own career that his influence became very important to my professional development. The stuff he was saying confirmed all of the things I had witnessed with my own eyes and ears at the brokerage firms I had worked at for ten years, I just didn’t know how to put it all into words. Carl knew how to do that and how to put these things into simple to understand drawings as well. It was a game-changer for me when I came across his stuff.

When Carl took one of his most famous cartoons and turned it into a limited edition print run of framed artwork, I got number 2 out of a run of 100 (Barry got number 1). This still hangs on my office wall, 13 years later, framed, signed and numbered:

What I love about this is how funny it is and how true it is at the same time. And how evergreen. People are people, whether it’s the 1860’s or the 2020’s. Everything about the markets can change, but people - and the incentives that drive their behavior - never will. Fear and greed are the two permanent conditions of humankind, regardless of all else that may be different from one generation of investing to the next.

Carl’s drawing, hovering angelically just above my right shoulder on the office wall, is my permanent reminder.

50 Fires

I tell you this story because this past week I had the good fortune to join my friend Carl for a discussion about money. He launched a new podcast to have these conversations with people from all walks of life. he is relentlessly fascinated by people’s lives and stories and that enthusiasm really comes through in the interviews.

Special thanks, by the way, to Josh Passler the FinArtist for this awesome cover:

On the podcast we got into some stuff about my first childhood memory involving money and how I am teaching financial concepts to my children. We talked about my career and the gigantic chip on my shoulder fueling it. I never do this stuff but Carl is really good at getting people to open up. I hope you enjoy our discussion and have as much fun listening to it as we did recording it.

You can listen to the whole thing on Apple Podcasts below, or find it on your favorite podcast app.

That’s all from me. See you tomorrow night on What Are Your Thoughts, live on YouTube at 5pm ET.

Talk soon! - Josh