Hi Guys,
“Closely following daily fluctuations is a losing proposition, because the pain of the frequent small losses exceeds the pleasure of the equally frequent small gains.”
Who said that? No, logical as it might seem, in this instance it is not John Bogle, although that’s not a bad guess. The author of this penetrating bit of financial wisdom is the famed behavioral psychologist Daniel Kahneman.
The quote was extracted from his powerful and comprehensive book “Thinking, Fast and Slow”. The book provides a definitive and readable guide to his life’s work while tracing the discoveries of the behavioral science discipline. Useable lessons can be readily learned from every page. I encourage you to secure a copy.
Earlier in the same paragraph Kahneman observes that “The combination of loss aversion and narrow framing is a costly curse”. He concludes that the curse can be substantially mitigated by far less frequent checking that exhorts a broad-framed time horizon.
The statistical basis for Kahneman’s recommendation is that the daily equity markets return positive gains only slightly more than one-half the time (like 51 %). That 50/50 statistic might suggest a rather neutral emotion to daily returns except that we suffer more pain, anxiety, and fear (like double) from losses than pleasure from profitable days. Winning does not launch the same joyous euphoria as losing promotes dismal regret.
From countless physiological experiments, the pain/pleasure utility curve has been demonstrated to be both very asymmetric and nonlinear in character. That notional curve is the essential element of Kahneman’s and Amos Tversky’s Prospect Theory (1979). Prospect Theory adds another dimension of complexity and refinement to the Statistician’s maximization of Expected Return axiom. The additional layer of complexity is the introduction of a normal person’s behavioral biases and tendency to overly overweight the intuitive, reflexive portion of the brain in the decision making process.
One superb example of the insights that Prospect Theory delivers is a 2 X 2 matrix that Kahneman and Tversky called the Fourfold Pattern. Gains and Losses compose the horizontal elements in the matrix; High and Low probability likelihoods represent the vertical components of it. The matrix identifies risk averse tendencies in the High Probability/Gains and the Low Probability/Losses matrix boxes, and risk seeking biases in the other two box positions.
This matrix organization helps to explain why high payoff lotteries (huge potential winnings coupled with a low success likelihood) are successful. Nassim Nicholas Taleb’s Black Swan investment strategy nicely falls into the same box category.
Kahneman divides the global population into two grossly unequal (by number) groups: the Econs and the Humans. The Econs are statistically oriented folks who make decisions to maximize expected profits or utility; Humans do not share this devotion to an uncompromising numbers game. Econs favor assessing results in the aggregate over a long term horizon; Humans are more immediate in their judgments and seek quick satisfaction. Econs typically use statistics to establish a base-rate to function as an anchor, and modify strategies and tactics to service situational differences; Humans do not and are more susceptible to false anchors, overconfidence, and an endowment effect (if you own it, you value it more dearly).
Successful gamblers and seasoned investors understand that losses are part of the game and accept the risks knowing that over the long haul statistical regression-to-the-mean operates to bolster their prospects. Not exposing yourself to self-inflicted daily market vicissitudes will make you a better long term investor and will likely improve your end-wealth investment performance.
Fortunately, I count myself among the Econ group. I do not know the current value of my portfolio and am not motivated to secure a daily update. In fact, I will not evaluate it until year’s end. Quarterly reviews are sufficient for my purposes, for my sanity, and for my happiness. I encourage you to consider adopting a similar policy.
University of California financial professors Brad Barber and Terrance Odean reported in a 2000 study release that “Trading is Hazardous to Your Wealth”. So is frequent portfolio monitoring which promotes too much worry and allows for the influx of unproductive emotions.
Time is a precious commodity and is a one-way directed arrow. Please don’t waste it chasing phantom performance persistence and false promises. Although they approached the investment issue from two orthogonal directions, that seems to be both John Bogle’s and Daniel Kahneman’s constant message. Both Titans recognize that luck is a huge residual factor even after slow, deliberate, reflective thinking and statistically-based investment decisions are made.
Kahneman’s additional wisdom, earned by decades of fruitful behavioral research, is that all individual investors would benefit by pushing away from the computer monitor to permit the march of time to aggregate portfolio rewards.
In closing, Kahneman’s perceptive takeaway is that pain exceeds pleasure with constant exposure to market volatility, especially given these turbulent days. So turn the monitor switch off; it is highly likely that your portfolio performance will not suffer, and possibly might even recover more quickly. Academic research firmly establishes that investors often make the wrong move at the wrong time.
On average, when we decide to trade, we sell holdings that increase in value after the transaction while investing in entities that don’t gain as much as our earlier holdings. As a cohort, Dalbar studies document that amateur investors do not score market rewards. Patience and persistence are not some of our stronger attributes.
As always, the final choice is yours. I wish you a firm statistical baseline when anchoring your decisions, and especially good luck when executing them. Stay the course.
Best Regards.
Comments
"Econs favor assessing results in the aggregate over a long term horizon."
I will have to presume, as I do not have access to data; that many "Econs" did not fare well in the market melt of 2008; as they were unable to determine what was taking place in the present moment and for what reasons. 'Course, if they didn't sell after the fact and at the bottom; due to long term horizons, they may be okay today with their total returns.
As to turning off the monitor or reviewing current activity with one's monies; so as to not get whip-sawed by poor judgements; I will relate this to a 600 page book, with 12 chapters. One only reads the first three paragraphs of each chapter, at the beginning of each and every month until the end. Some may, but I probably would not get the full meaning or impact of whatever subject matter the writer was attempting to enlighten.
This method would have caused most serious problems for my understanding of basic electricity and electronics many years ago.
One may imagine an investor not paying much attention for the past few years; and especially in May of 2010 and 2011, and today wondering what all the fuss is/was about what.............Greece? What does Greece have to do with anything? They have some tourists, export some alcoholic based drinks, olives/olive oil and yogurt. Their (the investor) painting canvas of investment knowledge would be short a few bottles of the very colors they needed to make a decision for continued investment painting.
Thank you for the note; and to each his own, eh?
Regards,
Catch
The other day in the RIT Capital Partners (which I own) letter from Jacob Rothschild, he said, "These have been some of the most torrid markets of my lifetime. In these exceptionally volatile markets our main focus
remains one of not chasing the pendulum swings between “risk-on” and “risk-off”; it is to identify areas
of opportunity beyond the present uncertainty." I think that's what I'm looking for - longer-term themes and ideas that have a 5+ year view on. More of my portfolio now than ever is what I would consider long-term investments - things that I can imagine owning for 5-10 years.
Thank you for your well crafted and insightful perspectives. I really do respect them.
My original submittal advocated ignoring daily market perturbations. That is obviously bad advice if the investor is a day-trader whose performance depends on minute-by-minute pricing changes. But most private investors don’t fall into that high-wire category.
By recommending that investors should switch off their monitors, I certainly did not mean forever; forever is too, too long. I do not endorse abandoning the news cycle; I am simply suggesting an incremental adjustment. I often fear an information overload condition. I can not process all the information that I can now all to easily access.
I fully understand and guardedly appreciate that easy access. Keeping informed is essential to investment success, but there also is a dark side to all that exposure. Some of the reporting is superficial, some just sensationalism, some self-serving, some corrupt, and some just plain wrong.
Our mass media, and I especially include unregulated Blogs in this generic grouping, sometimes create and/or perpetuate false crisis. None of these contaminated news flashes and questionable insights contribute to a winning portfolio, except perhaps for the unscrupulous villains who initiate these scams. Unfortunately, investors often are victims to this bad information. We also tend to overreact to legitimate news story by overestimating their market impacts. Things normally regress to the mean and do not approach extremes.
I still subscribe to the LA Times and the Wall Street Journal daily. Since I am definitely “old school” by both age and inclination, I still dutifully read them. But I do not react quickly. I consult alternate sources, I await developments, I assess events from a longer term perspective. I do make changes, but do so deliberately and incrementally. We can never know the future with precision or with anything approaching certainty. I invest accordingly and rely upon broad diversification axioms.
I apologize if my posting appeared too hard against staying current. Being informed is the backbone of solid portfolio management. But too much of a good thing can do damage.
Best Wishes.
Kinda early for possilbe full function of the brain cells at this house; and today's "to-do" list is already too big. Past all of this, I will attempt a few trinkets of thought.
"My original submittal advocated ignoring daily market perturbations. That is obviously bad advice if the investor is a day-trader whose performance depends on minute-by-minute pricing changes. But most private investors don’t fall into that high-wire category."
>>>>>Not a day trader at this house, and I suspect very few here at MFO are day traders; or if so, they may use small pieces of their portfolios for such actions.
By recommending that investors should switch off their monitors, I certainly did not mean forever; forever is too, too long. I do not endorse abandoning the news cycle; I am simply suggesting an incremental adjustment. I often fear an information overload condition. I can not process all the information that I can now all to easily access.
>>>>>Information overload potential indeed does exist. The individual needs to understand their capacity to deal with and use the information to their advantage as much as possible. At the very least, an individual needs to attempt to make a list of what they eventually understand to be the most crucial to their investments. There are a select few folks who have great capacity to "see" or "feel" market sector movements from their gift of having a most superior functioning brain. A non-political mention and example would be former President Bill Clinton, regardless of one's feelings about his politices or personal failures; I suspect he is able to recall and "vision" in his mind, just about everything he has every read, heard or uttered. I have a niece and nephew with this gift. In a conversation about "x", in many cases they are able to state that so and so wrote or said such and such in a book that they had read 10 years prior. I do not have this gift, with the exception of little trinkets of data that comes forth periodically when needed to perform some tasks. I also suspect that I am very average for the total population, as related to brain functions and thinking.
For me, this is where practice and repetition show their faces to aid my decision making as related to investments; and also applies to other areas of my life.
I fully understand and guardedly appreciate that easy access. Keeping informed is essential to investment success, but there also is a dark side to all that exposure. Some of the reporting is superficial, some just sensationalism, some self-serving, some corrupt, and some just plain wrong.
>>>>>Ah, yes; indeed. Whether I consider some data, talk or writing to be trash talk; I still must attempt to sort some of this away from reality. Perfect examples of some of this; although I consider the chatter to be from a fear factor versus the other most complex issues are the problems in Europe. If one were to line up the short sound bites coming from 20 or so of the most influentical leaders in Europe over the past 12 months; one will find utterances over and over that really don't say much, but I feel the statements are/were made in an attempt to calm investment markets. These folks know how nasty the problem areas are and will continue to be for years ahead. I shake my head with some of the statements that do not really say much and in some cases don't make much sense; at least in the realm of "common sense".
Our mass media, and I especially include unregulated Blogs in this generic grouping, sometimes create and/or perpetuate false crisis. None of these contaminated news flashes and questionable insights contribute to a winning portfolio, except perhaps for the unscrupulous villains who initiate these scams. Unfortunately, investors often are victims to this bad information. We also tend to overreact to legitimate news story by overestimating their market impacts. Things normally regress to the mean and do not approach extremes.
>>>>>All of this/these can indeed have a negative or positive impact upon an individual and their investment choices. Reactions to any of this are indeed in the hands of the receiver of such information. The increasing amount of info/data streams will continue to grow. Obviously, you or I can not fix how any one person deals with this. This is another part of practice and growth that comes from living and experience. How folks sort out this info ultimately boils down to the most basic characteristics of who the person is and understands about themselves.
As you have noted many times with your writes; and is appropriate, much of investing boils down to "know who you are". We all attempt to obtain this most wonderful status in life, and I suspect will not attain a most pure form of this; but we keep trying, through true study of a given topic. But, the pure fact of life experiences have a most profound affect upon knowing who we are. Exposure to the "topic" and the simple fact of obtaining more knowledge; are related to no more than the fact of the clock time of life.
I still subscribe to the LA Times and the Wall Street Journal daily. Since I am definitely “old school” by both age and inclination, I still dutifully read them. But I do not react quickly. I consult alternate sources, I await developments, I assess events from a longer term perspective. I do make changes, but do so deliberately and incrementally. We can never know the future with precision or with anything approaching certainty. I invest accordingly and rely upon broad diversification axioms.
Although I no longer read many paper copies of any publication; I still must assess and access data that I feel is the most critical at any given time and what the possible ramifications may be upon our investments.
I apologize if my posting appeared too hard against staying current. Being informed is the backbone of solid portfolio management. But too much of a good thing can do damage.
>>>>>No apology is required. We all have our thoughts about any of these areas; and the more we here at MFO toss around the thoughts; the more enlightened one should be able to become.
Would I be able to teach what I think I know; or better yet; what I think I feel or has become intuition towards investments suited to our house? I am not so sure I would be able to present, in a fact based manner; how to attempt to be intuitive. I really believe many people are most intuitive (that gut feeling) about decisions related to investments or other areas of their lives. The most difficult circumstance is the ability to become confident with the intuition; the feeling of knowing that one begins to better understand and use the intuition to the positive, or at the very least to help reverse the negative. In hindsight, I look at various market sectors that I should have been invested in during 2011 or at least particular times of the year. I look back and wonder about "why" didn't I do that. My own intuition and always trusting it still continues to grow. Such is our frail human nature, eh?
practice and repetition as I noted above, are important for me. I fully understand my lack of capacity to learn certain things. I recognized and understood when I ran into walls of knowledge capacity from a young age. While this can be frustrating, at least I knew that I understood the barriers. I either had to pursue and try to break certain subject barriers, or to realize that there were other productive areas of life for me that were natural and easy to grasp. I took advantage of those areas to move forward.
As to the practice and repetition; I can attempt a few examples, but one may fit my examples into what they are most familiar, for your own examples. At least in my view, this ties into your points of too much information and the possible "knee-jerk" reactions related to investment choices. My theme could be noted as a "be ready" scenario.
Baseball & NASCAR:
---Totally unrelated (market sectors) types of sports, but related as to being sporting events (the investment marketplace in whole).
---Both sports have common factors:
1. players/drivers do not have to perform everyday (not day traders)
2. players/drivers have to perform with multi-variables in place; stadiums/tracks have different layouts, night/day games or races, dry or wet, hot or cold are some (all areas one feels they need to monitor for peak investment performance within a framework of forward unknowns).
3. practice and repetition (monitoring circumstances that will affect one's invesmtents); so that when the game/race (investment moves) arrives; at the very least the players/drivers (individual investor) will have attempted to understand and deal with the variables that may present themselves without much prior notice.
Our house will continue to monitor as much info as we have capacity to deal with; and hope that such info will allow us to at least preserve our current capital and hopefully grow the same a little bit.
I surely failed to place some other thoughts with this; but I must be on my way. Perhaps the words may be of value for at least one person.
Thank you for your time and take care of you and yours,
Catch
However, let's not be too critical of ourselves. Most are likely drawn here with a keen interest in financial markets. As a backhanded complement, I'd say most financial TV is somewhat more stimulating to the brain cells than most else that's on TV these days. (Milton Minnow's probably rolling over in the grave by now.)
In ending, I do agree with your observations that this continuous hype tends to make us trade more with possibly deleterious effects on our investments. Let me add: the more folk (and computers ) trade, the crazier the markets become and the harder it is for small (ie: "mom & pop") investors to adhere to even the best designed plan.
http://www.zerohedge.com/news/hedge-fund-insider-explains-why-retail-investors-should-flee-stock-market
I don't think that everyone should flee entirely, but I do think the tables continue to be tipped bit-by-bit, year-after-year in a way that's definitely not in favor of the retail investor.