Many investors feel that they should, or even must, “stay on top of market news.” While we definitely believe it is important to monitor the overall state of the economy and global trends, investors should be careful not to over-consume information. For most people, closely watching the daily ups and downs of the market will just create worry and result in lower returns over the long term. This is because watching your investments may cause you to:
- Trade too frequently based on past performance, thereby increasing your costs and lowering your future returns.
- Simply create anxiety due to completely normal, short-term fluctuations.
- Reduce your willingness to take “smart risks” based on overall market conditions.
Chasing past performance:
The standard refrain in finance is “past performance is not indicative of future performance.” Focusing too much on the recent past can harm your returns in a variety of ways. For instance, chasing “winners” can be risky. Just consider the recent run of GameStop — it grew tremendously but has lost much of that value. Jumping in to an investment at the wrong time can result in tremendous losses.
Variation and Anxiety:
Because of normal market volatility, the market will go down nearly 50% of the time. This is o.k., because the market tends to go up a bit more, and often enough, to compensate for this variation. This is why investing for the long-term is critical.
However, even though we know down days are normal, our emotions do not always behave. Indeed, down days feel like losses, and losses hurt. In fact, a common finding in behavioral science is that people are loss averse: a loss is felt relatively more strongly than an equivalent gain. As a simple example, a loss of $5 evokes an emotional response of the same magnitude as a $10 gain. Put another way, you really do not want to go back to the life you had as a student with no money.
Risk vs Reward:
We’ve all heard the phrase “nothing ventured, nothing gained.” This holds in the market, too; a certain level of risk is crucial for long-run wealth building. But the right level depends on your own preferences, time-horizon, and future plans. You do not want bad information keeping you out of good risks.
However, an experiment from two Nobel-prize winners shows that focusing on recent performance may stop us from taking on risks that are good for us. Students provided with information on returns for shorter lengths of time invested less, leading to worse returns over the long-term. This effect was also found among workers’ 401(k) decisions.
This is especially relevant since most stocks will have bouts of poor performance. Because people really dislike losing (because they are loss averse), focusing on these recent losses might induce investors to sell, or keep them out of the market, when they would be better off buying. As a recent example, Facebook stock performed poorly much of 2018 following the Cambridge Analytica scandal. However, it has since surpassed its previous highs and provided excellent returns.
Because of these reasons, most investors would benefit from a disciplined approach and less monitoring. At Brains, we help you find a diversified portfolio based on your own willingness to take risk and your beliefs about the long-term. Once you’ve settled on a portfolio, set it, forget it, and let it grow.