Why Watching Stock Prices is Injurious to Your Health
MAS Team | 21 October 2016
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In his latest book Misbehaving, Richard Thaler, the foremost behaviourial theorist mentions a couple of interesting experiments that has profound implications on how we should approach our investing. A few years ago, students University of California, Berkeley, were given the job of investing money for a university endowment. They were doing a mock exercise, but were supposed to earn real money that varied between $5 to $35 an hour, depending on the outcome of their mock investments. The students had only two investment options, a risky one with higher returns and a safe one with lower returns. 
 
The key was what the students could see, as an outcome of their investments. Some saw their results eight times per year, while others saw their results once a year or once every five years. Those who saw their results eight times a year only put 41% of their money into stocks; those who saw the results just once a year invested 70% in stocks. This is one reason why people don’t invest in volatile products like equity funds and stocks even though they give far better returns over the long term compared to safe fixed income products. Most investors don’t stay invested for long.
 
The experiment of Berkley has recently been replicated in real life following a regulatory change in Israel. In 2010 the government agency that regulates retirement savings funds changed the way funds report their returns. Earlier, when investors checked on their investments, the first number that would appear for a given fund was the return for the most recent month. The new regulation replaced past month with past year. After this change, investors shifted more of their assets into stocks, as predicted by “myopic loss aversion” theory. They traded less often and were not tempted to chase recent top-performing funds. 
 
What are the lessons from these two experiments? The first lesson is for the regulator. Regulation can encourage sensible investing with clever behaviourial nudges. The second lesson is for investors. Looking frequently at your returns can induce two types of behavior: one, make you risk-averse and make you forget that stocks do well over the long term or two, make you risk-prone, getting you worried about the short-term underperformance and make you trade more often.
 
In their “myopic loss aversion” paper of 1993, Richard Thaler and Shlomo Benartzi used historical data and asked how often investors would have to evaluate their portfolios to make them indifferent between stocks and bonds, or want to hold a portfolio that was a 50-50 mixture of the two assets. The answer they got was roughly one year. As Thaler writes in Misbehaving: “Of course, investors will differ in the frequency with which they look at their portfolios, but once a year has a highly plausible ring. Individuals file tax returns once a year; similarly, while pensions and endowments make reports to their boards on a regular basis, the annual report is probably the most salient.”
 
Investors look at their portfolios too often and then start making mistakes. This is also supported by yearly studies put out by Dalbar, a Boston-based research firm. The studies that show that the market offers or mutual funds make are irrelevant. Investors always make far lower than that because they cannot stay put over the long period. This happens in India too. Take a look at this article.
 
Thlaer writes: “Whenever anyone asks me for investment advice, I tell them to buy a diversified portfolio heavily tilted toward stocks, especially if they are young, and then scrupulously avoid reading anything in the newspaper aside from the sports section. Crossword puzzles are acceptable, but watching cable financial news networks is strictly forbidden.”