Turn off the Noise - Part 3 of 4 on Market Timing

Noise and non-sense

First off, what do we mean when we say “noise”?  How about the daily and monthly movement of stock prices, or the latest headlines and the endless forecasting of the talking heads on TV and radio?   In our attempts to make responsible investment decisions we logically seek out as much info as possible to inform them.  But much of what we find is of no real value when making long term investment plans.

The challenge we have with data is that our ancient brains process them in ways that are not conducive to good decision making.  It stems from our inherent fear of loss.  And leads to what behaviourists call MYOPIC LOSS AVERSION.

Myopic Loss Aversion –is the combination of a greater sensitivity to losses than to gains and a tendency to evaluate outcomes frequently. The more frequently clients review their portfolio, the more risk averse they become due to the greater frequency that they observe losses occurring. 

In English:  The more frequently you visit an investment value the greater the likelihood of observing a negative result.  Negative results have larger impacts on our emotions, and lead to increased anxiety levels and false conclusions.

For example:

The chart* shows a hypothetical stock portfolio with an average return of 10%, and a standard deviation of 20% (approximate historical stock market returns).  Over shorter periods of time losses appear more frequently.  Real life experience approximates these results.

The tables on this page are from a paper “Risk Aversion or Myopia” by Benartzi and Thaler.  The table of 1-year returns (taken from 10,000 random drawings of US stock and bond returns between 1926-1997) was presented to one group of subjects while a second group was presented with the 30-year annualized return numbers.  Each group was then asked how much they would be willing to allocate to stocks.  The first group (1-year) median allocation to stocks was 40% whereas the second group’s (30-year) median allocation was 90%!

Explanation was that the first group was fooled (by seeing lots of one year losses) into believing the long-term risk of equities was greater than it truly is.   

The evidence is firm, an increase in the global exchange of information via 24 hour TV, internet, newspaper and business news radio hasn’t helped investors attain their goals.   The chart below demonstrates this disparity well:  average stock funds in the US actually return fairly well, but the investors in those same funds do not  - a difference of over half of the return on the fund.  This difference between the two values can be largely explained by our over confidence in our ability to get in and out of those funds at right times.  Beware the noise, it taps into that survival instinct in your brain that screams "run!"; it narrows the vision, and limits your ability to remain calm in the storm.   

Do your retirement a favour and learn to avoid the noise.   It takes a while to be able to discern between valuable financial education and plain old business news entertainment, but it’s worth the effort.