The Investor Behavior Gap: Why Smart People Make Costly Investment Decisions

Silicon Valley rewards conviction, speed, and optimism. Those same traits can work against long-term investors.

Every year, the research firm DALBAR compares the returns of the average equity mutual fund investor with the returns of the market itself. In many years, DALBAR's findings have shown the average investor earning less than the market. According to DALBAR's 2026 report, the average equity investor earned 17.16% in 2025 compared with 17.88% for the S&P 500, a gap of 0.72 percentage points. DALBAR reported that this was the third-smallest investor gap since 1985 and the smallest since 2012. Results vary significantly from year to year, and the comparison does not establish that any particular investor experienced similar results.

Why the gap exists

DALBAR uses the investor gap as one measure of the effect investor behavior may have on realized returns. Morningstar's Mind the Gap US 2026 study, which uses a different methodology, estimated that the average dollar invested in US mutual funds and ETFs earned 8.7% per year over the 10 years ended December 31, 2025, about 1.2 percentage points per year less than the funds' 9.9% aggregate total return. Morningstar attributes that gap to the timing and magnitude of investors' purchases and sales. These estimates are debated: a 2026 study in the Financial Analysts Journal concluded that poor timing cost mutual fund investors only about 0.10% per year. Academic research in behavioral finance has described a number of tendencies that may contribute to timing-related shortfalls, and in our view several are especially relevant to technology professionals.

Overconfidence. In our experience, people who are highly skilled in one domain may assume that skill transfers to investing. An engineer who can evaluate a system architecture may believe they can evaluate a stock with the same rigor, without recognizing that markets aggregate the views of millions of participants with the same public information.

Familiarity bias. In our experience, many Bay Area investors tend to own what they know: their employer, their employer's competitors, and the technology sector broadly. We believe this can result in a portfolio that is highly correlated with an investor's career and home value.

Recency bias. After a long run of strong technology returns, it is natural to extrapolate. After a sharp decline, it is equally natural to expect further losses. Neither is a reliable guide.

Loss aversion. Research by psychologists Daniel Kahneman and Amos Tversky (“Prospect Theory: An Analysis of Decision under Risk,” Econometrica, 1979) suggests that many people feel losses more strongly than equivalent gains. Loss aversion may contribute to decisions such as holding losing positions in anticipation of recovering losses or selling appreciated positions prematurely.

Anchoring. Employees often anchor on a stock's all-time high or on the price at a previous funding round. A decision to hold until the stock "gets back" to a number is an anchor, not an analysis.

The cost of activity

Frequent trading or strategy changes can increase transaction costs and, in taxable accounts, may create tax consequences that affect an investor's after-tax return. For example, selling an appreciated position in a taxable account generally realizes a capital gain, which may be subject to federal and California income tax and, for taxpayers above certain income thresholds, the 3.8% net investment income tax. Sales at a loss do not generate a taxable gain. The IRS explains capital gains rules in Topic 409.

Approaches some investors consider

Behavioral research does not suggest that investors should never act. In our view, it may be helpful to make decisions according to guidelines set in advance rather than in reaction to events. The practices below are ones some investors consider; none of them guarantees better results, and whether any is appropriate depends on individual circumstances.

• A written investment policy. Documenting a target allocation, rebalancing thresholds, and the conditions under which you would change course may provide a reference point for future decisions. Periodic reviews may help investors evaluate their portfolios in the context of their objectives rather than reacting solely to short-term market developments.

• Automation. Regular contributions, automatic rebalancing, and pre-scheduled sales of employer stock, including Rule 10b5-1 trading plans for company insiders, may reduce the number of decisions made at emotionally charged moments. Rule 10b5-1 plans are subject to specific legal requirements, including cooling-off periods, so insiders should consult their company's legal counsel and a qualified tax professional before adopting one.

• Framing decisions in terms of goals. Asking whether a portfolio can still fund retirement, education, or a home purchase is more useful than asking whether it is up or down this quarter.

• Separating speculation from the core. Some investors choose to distinguish higher-risk or speculative investments from assets designated for longer-term financial objectives. Whether such an approach is appropriate depends on the investor's objectives, risk tolerance, time horizon, financial circumstances, and overall portfolio.

• A decision journal. Writing down the reasons for a trade at the time it is made, and revisiting the entry later, is a simple way to calibrate your own judgment.

  
  

The role of an adviser

A financial adviser can serve as a sounding board before a major financial decision, for example by helping an investor consider what has changed in their plan rather than only what has changed in the market. Working with an adviser does not guarantee better investment outcomes, and every investor's circumstances are different. In our view, having a written plan and a process for revisiting it may help some investors stay focused on their long-term objectives during periods of market volatility.

This article is for educational purposes only and is not investment advice. All investing involves risk, including the possible loss of principal, and past performance does not guarantee future results.

Important Disclosures

Important Disclosures: Propulsion Capital Management is an investment adviser registered with the State of California Department of Financial Protection and Innovation. Registration does not imply a certain level of skill or training. This article is provided for general informational and educational purposes only and does not constitute investment, tax, legal, or accounting advice, nor an offer or solicitation to buy or sell any security or to adopt any particular investment strategy. The information is believed to be accurate as of the date of publication but is subject to change without notice; tax laws and regulations change frequently and their application depends on individual facts and circumstances. Nothing herein should be relied upon as a substitute for personalized advice from a qualified professional. Investing involves risk, including the possible loss of principal, and past performance is no guarantee of future results. Diversification does not ensure a profit or protect against loss. Any examples are hypothetical, are for illustrative purposes only, and do not reflect the experience of any client. Links to third-party websites are provided for convenience; Propulsion Capital Management does not endorse, and is not responsible for, the content of third-party sites. Propulsion Capital Management does not provide tax or legal advice; please consult your tax adviser or attorney regarding your specific situation.