You’d have to have been living under a rock, meditating in a Buddhist monastery high in the Himalayas or lost at sea to not know that global sharemarkets have been taking something of a beating over the past couple of months.
With headlines like “Local sharemarket sheds $50 billion in worse one-day fall since February” screaming at you from your morning newsfeed it can be difficult to keep a sense of perspective when the occasional, invariable, bout of market jitters occurs. There is more than a grain of truth to the old news adage, “If it bleeds, it leads”.
Some researchers suggest that humans may have a “negativity bias” hardwired in our subconscious, and that our brains are more sensitive to signs of threat than to those of opportunity.
In prehistoric times such a bias could well have been an advantage, keeping early humans safe from harm. But in today’s world of global, instantaneous, round-the-clock news, that bias to action in the face of danger could end up costing you a fortune.
Dealing with temporary market falls
No one likes losing, and when financial markets are falling that’s exactly what it feels like.
People go to great lengths to avoid these feelings of loss. Researchers who study human behaviour call this tendency “loss aversion”, and studies suggest that we tend to feel the pain of a loss twice to two and a half times more than we feel the pleasure from an equivalently sized gain.
This sensitivity to losses over gains is a big part of the reason why investing is so tough for most people.
It’s not that we don’t know that investing should be about the long-term, and about allowing time for growth assets like shares, and the effects of compounding, to grow our wealth. It’s that our danger-avoiding brains scream at us to flee for safer ground when the pain of financial loss starts to mount.
For many investors that means selling when markets are turbulent, like the sort of jitters global sharemarkets have experienced since October this year.
Small edges add up over time
So how do we stop this very human tendency to bail on our investment strategy and flee to the safety of cash when we see our investment portfolios start to wobble? By understanding what we might be giving up.
We’ve written before about how just a handful of trading days in a multi-year investment program will likely determine your ultimate return, with one Australian study showing how missing the 40 best days out of more than 5,600 trading days reduced the end value of a $10,000 investment from almost $69,000 to less than $16,500.
A similar study in the US found that a mere 90 trading days between 1963 and 1993 accounted for 95% of the market gains over that thirty year period.
Think about that for a minute. You only had to miss out on the three best trading days each year over a 30 year period to cheat yourself out of the vast majority of gains accrued by the patient investor who simply remained invested.
The more you watch, the less you earn
Here’s the thing about sharemarket investing. The probability of any one trading day being either positive or negative is almost 50-50, but not quite.
In fact it’s ever so slightly positive, which over the long-term begins to turn the odds of a positive outcome massively in favour of the buy-and-hold, stay-the-course investor.
Investment academic, author and former quant investor Nassim Nicholas Taleb, in his fabulous book on chance and investing, Fooled by Randomness, outlines the case of the hypothetical retired dentist who sets himself up as an active share trader, watching each price tick in his portfolio every second of each trading day. Monitoring the portfolio from second to second, Taleb notes that:
” ….[s]een at a narrow time scale, this translates into a mere 50.02% probability of success over any given second as shown in the table. Over the very narrow time increment, the observation will reveal close to nothing.
Yet the dentist’s heart will not tell him that. Being emotional, he feels a pang with every loss, as it shows in red on his screen. He feels some pleasure when the performance is positive, but not in equivalent amount as the pain when the performance is negative.”
By being so engaged with his investment portfolio, the retired dentist has created an environment where his brain’s flight response will act against his own best interests.
Few investors, professional or otherwise, would be able to put up with the discomfort of being “wrong” nearly half the time, and the most likely long-term outcome would be for the dentist to transfer a good deal of his hard-earned wealth to other, more patient, investors.
Flight to cash guarantees a poor outcome
Investors the world-over are currently hurting from the recent market correction. No doubt many have gone past their pain threshold, sold and parked the proceeds in cash, hoping to buy back into the markets when they recover.
If you’re thinking of the same, then consider the following three points:
- Trying to time the market is notoriously difficult. If it were possible to consistently sell at or near a short-term high and buy back at or near a short-term low there would be some evidence of timing skill. But countless studies have failed to find any such evidence of timing skill, even among the most sophisticated investment managers. Not to mention that by opting to sell you’ve just created a future problem; picking the right time to get back into the markets.
- If your portfolio had grown in value from the time of your investment to the time it was sold, you may have to give some of your gains to the tax office in the form of capital gains tax. If the portfolio was held for less than 12 months, no discount would apply to this gain, which could materially impact how much of the gain you actually keep.
- Moving your money into cash isn’t going to help you. According to ABS data, interest rates for high interest savings accounts are currently around 2.10% p.a. If you’re on the 37% marginal tax rate (taxable income between $87,000 and $180,000), your after-tax return on that parked cash will be 1.3% p.a. However, inflation is currently running at 1.9% p.a., meaning that your actual after-tax real return (i.e. adjusted for inflation) for money sitting out the market volatility will be -0.60% p.a.
There is no surer way of losing money, in the current low interest rate environment, than holding more in cash than you absolutely need to meet your short-term requirements.
To build wealth, turn off the noise
There’s a reason why Warren Buffett reputedly does not have a computer on his desk, and has chosen to build his investing empire in Omaha, Nebraska, a town with fewer than 500,000 people.
Buffett knows that what passes for investment news is mostly just worthless noise, designed to capture people’s attention and spur them into action, when inaction and patience will likely serve them better. He’s built a fortune worth over $90 billion dollars in part because of his remarkable ability to avoid the investment noise that is all-pervasive today.
If you want to be a better and more successful investor, turn off the noise.
- Check your portfolio as infrequently as possible. Once a month if you must, but once a quarter is better
- Turn off notifications to any share watchlists, trading apps and investment news updates
- Adjust portfolio updates you receive to be as infrequently as possible
- Remove investment websites from your browser tabs so that they don’t load automatically
You can choose to be like Buffett, or you can choose to be like the retired dentist in Nassim Nicholas Taleb’s book. Ultimately it’s your money and your choice. So choose carefully, because it’s a decision that has massive ramifications for your financial future.
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