Investing is not a scientific pursuit; it is influenced mainly by our emotions even though we rarely acknowledge that fact. Why, for instance, do many people who invest directly in a small number of publicly quoted companies spend most of their time worrying about the worst-performing stock rather than viewing their portfolio in totality.
One reason for this is something called “Loss Aversion”. This is the tendency for human beings to favour avoiding losses to acquiring equivalent gains. The term “loss aversion” was first coined in a 1979 paper by psychologists Daniel Kahneman and Amos Tversky. Kahneman’s subsequent research into the cognitive processes and psychological science behind economic behaviour earned him the 2002 Nobel Prize in economics. Loss aversion is a bias that has existed and evolved in human beings since the beginning of time. We cannot remove loss aversion from the human psyche but we can be aware of it and how it can affect our investment decision making.
Let’s look at the S&P 500 as a benchmark for the overall stock market. Based on the performance of the S&P 500 Index from 1990 through 2020, investors who check their portfolios on a daily basis can expect to see losses 47% of the time and gains 53% of the time. In other words, in over 30 years of the stock market trading, 47% of days are negative and 53% are positive. Ok, so more winners than losers, great! Unfortunately, it’s not that easy, while investors will see gains more frequently than losses, because the average investor tends to feel the pain of a loss twice as much as an equivalent gain, the more often investors check the value of their portfolios, the more net pain is felt.
Many investors find it surprising that, for a market that averages annual growth of close to 10% for the same period, 47% of trading days were negative. However, if you monitor the same index at different intervals the results become slightly more predictable. Over the same period (1990 – 2020) investors who resisted the urge to check their portfolios daily and moved to a monthly check, experienced losses only 38% of the time and gains 62% of the time. The results move to 32% loss and 68% gain for those who check quarterly. If you manage to look at your portfolio only once every year, you will find gains 77% of the time! Check your investment less and you should reduce the amount of temporary loss-induced pain you feel.
Checking in on your investments too regularly often leads investors to develop a short-term view of the market. This can be costly particularly for the more risk-averse investor who is most likely to check in regularly. They end up focusing on short-term volatility and, as a result, tend to invest too little in what they believe are “risky’’ assets. In a time where investing 75% in so-called “risky assets’’ is required to yield 5.3% pa, up from 25% “risky assets’’ 10 years ago, now is not the time to be risk-averse! (Estimates based on JPM Long Term expected returns)
To the best of your ability, try to avoid checking the value of your investments on too regular a basis! If you cannot resist, make sure to look at performance through longer-term lenses. Spend your time focusing on the things that you can control, the amount you save, your lifestyle expenditure and your long-term Financial Plan which should be your financial roadmap framing all your financial and lifestyle decisions. Your investments are only one part of an overall financial plan, an important part no doubt, but still only one part.