The Pain Of Patience: How Excessive Short-Term Focus Hurts And Ways To Combat Our Tendencies by Fund Evaluation Group
by Gregory D. Houser, CFA, CAIA / Senior Vice President, Capital Markets
“Despite the best of intentions, investors often fall short of their long-term goals due to excessive focus on the short term.”
The U.S. equity markets have been on a tear. I am not referring to the short-term performance year-to-date, but the short-term performance of the past three years. U.S. equities, regardless of the index selected, returned approximately 20% annualized since June 2012. Despite double-digit returns from developed international equities over the same period, weakness in emerging markets and just about everything else has led many to question their holdings.1 Much like those investors that felt left out and wanted to jump on the tech-fund bandwagon during the late 1990s (we know how that ended), many investors have similar reactions to recent performance today and have considered abandoning diversification for an S&P 500 Index fund, if only for a minute. I would not be surprised if many of these investors also considered abandoning equities during the financial crisis, because these reactions are only natural, and no one is immune.
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Counter to the feelings of missing out on recent strong performance, 2008 and early 2009 was a stressful and painful time to be an investor. Daily equity market declines of four to five percent were almost commonplace. Declines of this magnitude created stress throughout the world, across the financial system, and in the gut of every investor.
Having experienced loss in our lives, we might recall the lack of appetite, difficulty sleeping, and anxiousness that comes during these times. Studies have indicated that our brain activity for financial loss is consistent with the primary negative outcome of pain. In other words, losses really do hurt.2 The type of stress experienced during the financial crisis triggered for many investors the natural fight-or-flight response and a desire to make the pain go away. The most significant challenge investors faced at the time was to ignore the short-term stressors and stay invested for the long term. Many investors were not up to the challenge. One can safely assume that the many equity sales at that time were heavily influenced by extreme investor stress and pain. When the equity market bottomed on March 9, 2009, someone was on the losing side of that trade. If you are one of those investors, please accept my apologies for triggering those painful memories.
The impact of stress manifests in us the same physiological response, irrespective of whether that stress is physical (an attack) or psychological (sudden financial loss). Our body’s fight-or-flight response shuts down long-term needs (digestion, the immune system) and heightens short-term systems (elevated blood sugar, increased blood pressure, amplified senses). This is a healthy reaction to being mugged (a short-term problem), but not a good method for maintaining a focus on long-term investing goals amid ongoing daily financial turmoil. Excessive stress responses wear us down physically, with the potential for long-term consequences as our bodies struggle to return to a balanced state.
So, stress creates the desire for action, and financial loss exacerbates the stress and triggers pain reactions. This is not a pleasant state in which to exist as an investor, and this state can lead to poor decisions, such as exiting the equity markets at the worst possible time. The stress and pain we experience is not limited to crisis moments; we feel the same effects when we experience weak performance, which can also lead to poor decisions. Despite the best of intentions, investors often fall short of their long-term goals due to excessive focus on the short term. This ‘short-termism’ harms not only near-term stakeholders, but also those who want to reach long-term goals, whether for inter-generational equity, retirement needs, or other future liabilities.
Maintaining the appropriate focus on long-term goals is difficult, and monitoring short-term performance makes this challenge more difficult. Simply looking at daily, monthly, or quarterly returns can trigger our sense of loss aversion. The equity market has historically increased in value over the long term, with many ebbs and flows along the way. Many have a belief that increased transparency is always best, but such transparency may not be optimal for a long-term investor’s portfolio. The probability that you will see a loss is slightly under 49% for a day, approximately 47% for a week, 25% for a year, and almost 0% for a 10-year period. Benartzi and Thaler illustrated that we generally feel suffering from losses at twice the rate we benefit from an equal gain.4 For the long-term investor, a myopic focus on portfolio performance (i.e.,excessively reviewing short-term performance) needlessly creates suffering.
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