With the power of smartphone technology an investor can view the value of their portfolio almost instantaneously and have the ability to trade on it from almost anywhere in the world. Most would think this is a huge advantage not only to the professional but also to the retail investor, giving them instant access to up-to-date pricing, stock movements and market news. This prompts the question; does this lead to better investor outcomes?
We view daily, even monthly, movements in financial markets as “noise”. These are short-term gyrations in markets generated by the ebb and flow of buying and selling decisions of different investors. There is little rhyme or reason to these movements other than the fact that you need two views to make a market, and participants have varying timescales, risk preferences and restrictions to their investments. Unfortunately these movements do have an impact on investors as most suffer from myopic loss aversion. Myopic loss aversion, defined by R. Thaler et al., “is the combination of a greater sensitivity to losses than to gains and the tendency to evaluate outcomes frequently”1. Translated simply, we feel the negative impact of losses twice as much as the positive impact of gains, whilst at the same time looking at our portfolios too often.
Myopic loss aversion would not be an issue if markets went up, even marginally every day. Generally however the journey to long-term positive returns is not a smooth one and is punctuated with negative spells. In fact, looking at the table below, taking historical US stock market data, the S&P 500, as a proxy for stock performance, on a daily basis the odds that stocks will go up are the same as flipping a coin. Extend your horizon to a year and there is almost a 75% chance they will be positive, and if you wait 10 years the odds are considerably in your favour with a 94% chance of positive returns.
S&P 500: 1926 – 2015
| Time Frame | Positive | Negative |
|---|---|---|
| Daily | 54% | 45% |
| Quarterly | 68% | 32% |
| One Year | 74% | 26% |
| 5 Years | 86% | 14% |
| 10 Years | 94% | 6% |
| 20 Years | 100% | 0% |
Viewing your portfolio regularly not only increases the odds of seeing short-term losses but also these losses are likely to make you feel worse to a higher degree, than you feel better when you see gains. Seeing regular (daily) losses on your portfolio is negative on your point of view and can cause you to deviate from your longer term objective and thus make unnecessary changes at the wrong time. Therefore, the less frequently you view your portfolio the more likely you are to see gains, as the probability for gains increases with a longer time horizon, and therefore the more likely you are to stick to your original long term objective.
Myopic loss aversion is inherent in all of us. Having the right frame of mind about short-term market movements is fundamental to avoiding an impact on the longer-term performance of your investments. Accepting that you have no control over short-term movements, having confidence in your investment approach and allowing time for it to work are integral to avoiding myopic loss aversion. At Taylor Money, our well-defined and disciplined approach to building portfolios helps mitigate against myopic loss aversion. Not only does this produce a better outcome for our clients, but also instils the appropriate mindset for long-term investing.
1. Richard H. Thaler, Amos Tversky, Daniel Kahneman, Alan Schwartz; The Effect of Myopia and Loss Aversion on Risk Taking: An Experimental Test. Quarterly Journal of Economics 1997; 112 (2): 647-661.
General Disclosures: This article is based on current public information that we consider reliable, but we do not represent it is accurate or complete, and it should not be relied on as such. The information, opinions, estimates and forecasts contained herein are as of the date hereof and are subject to change without prior notification. It does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. The price and value of investments referred to in this research and the income from them may fluctuate. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur.
