How often do you look at the stock market or check your investment portfolio?
The Digital Age has made access to stock market data and real-time portfolio values increasingly easy. The problem with easier access to real-time market data is that investors can lose sight of the big picture as their mental time horizons shorten to match the frequency of feedback rather than that of their planning time horizon.
The Wall Street Journal ran a related article titled Keep Stock-Market Apps Off Your Phone discussing how the frequent feedback people receive about their investments from their phones or other devices increases the likelihood they will make poor decisions. The theory supporting this article originated in a paper addressing myopic loss aversion.
Loss aversion is a behavioral bias that makes losses hurt about twice as much as a similar sized gain makes us feel good – the result is that investors tend to make poor decisions as a consequence of trying to avoid the pain of a relative or absolute loss.
What is Myopic Loss Aversion?
Myopic loss aversion is the idea that the more we evaluate our portfolios, the higher our chance of seeing a loss and, thus, the more susceptible we are to loss aversion. Additional research shows that investors who get the most frequent feedback also take a less than optimal amount of risk and earn less money.
On the other hand, investors that check their portfolios less frequently are more likely to find gains and, thus, less likely to make bad decisions stemming from loss aversion.
Myopic Loss Aversion Example
Using historical returns on the S&P 500, you have a 47% chance that the market will be down on any given day. However, if you were to wait longer and look at monthly returns, that percentage drops to 38%. If you only look once a year at the past 12 months of returns, the chance you will see a loss drops to 21%.
The table below shows different rolling periods and the percentage of time you would have historically experienced a positive or negative return.
|Rolling Performance for the S&P 500 (1926-2015)|
|*Data runs through 11/30/2015|
Most investors have a multi-decade time horizon whether they are just beginning to save, in the middle of their careers, or currently in retirement. However, evaluating your portfolio in quarterly or even annual intervals is making an evaluation as if you have a short-term planning horizon.
In addition, outcomes of a probabilistic system such as investing are far too random in the short-term to draw any meaningful conclusions about the success or failure of an investment. Rather than focusing on short-term results, a better course of action would be to evaluate the decision-making process.
A quality decision-making process is rooted in an investment philosophy that emphasizes evidence-based theory and research. A quality decision-making process should also protect us from our faulty mental hardwiring that causes us to misinterpret (or ignore entirely) probabilities, find patterns where none exist, and elicit emotional responses that were useful from an evolutionary perspective but detrimental to good investing.
I’m not suggesting that people should only look at their portfolios once every ten years – although I wouldn’t discourage it – but the worst behaved investors we encounter are those that are evaluating the stock market and/or their portfolios over short time periods.
We believe stock investing requires a long-term time horizon, which we’d define as at least 10-20 years. The long-term feels like an eternity to live through in the moment, but the most basic parts of financial theory look pretty darn good when you allow them time to work.
Sources and Disclosures:
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS. Investing involves risk. It should not be assumed that recommendations made in the future will be profitable or will equal the performance shown. Investment returns and principal value of an investment will fluctuate and losses may occur. Diversification does not ensure a profit or guarantee against a loss.
S&P 500 Index® is widely regarded as the best single gauge of the U.S. equities market, this market-capitalization-weighted index includes a representative sample of 500 leading companies in the foremost industries of the U.S. economy and provides over 80% coverage of U.S. equities.