How Data Visualizations Can Make You A Better (or fearful) Investor
How to avoid becoming a 'myopic investor'
In my book, I describe the concept of a ‘myopic investor’:
A 1997 paper written by Richard Thaler Et al. discussed how myopic loss aversion impacts investors. They define myopic loss aversion as “greater sensitivity to losses than gains and a tendency to evaluate outcomes frequently.”
They point to two behavioral traps that investors fall victim to.
Loss aversion. People hate losing more than they like winning.
Mental accounting. The narrow framing of current decisions and past outcomes leads to short-term rather than long-term thinking and constant evaluation of gains and losses.
Combine loss aversion with narrow mental accounting, and you get a myopic investor, someone who will constantly check their portfolio and feel deep pain when their portfolio is down.
Given the volatility in the stock market, the more you check your portfolio, the more often you will see your portfolio having a bad day. Of course, the number of good days will outnumber the bad days over the long run, but the myopic investor tends to forget the good days and hold onto the bad days.
They found that myopic investors will be more willing to take on more investment risk if they check their portfolio returns less often. Put another way, myopic investors who constantly check in on their portfolios take on less investment risk, have lower exposure to the risk premium provided by stocks, and make less money.
No matter what we tell ourselves, we are all, to some degree, myopic investors. The sooner we accept that fact, the sooner we can address the problem.
It’s never been easier to slip into the bad habits of the myopic investor for two reasons.
We have a constant barrage of information about what’s happening in financial markets from 24-hour cable news and social media.
It’s never been easier to access and make changes to your portfolio. Just pull out your phone, and within a few seconds, you can make a potentially devastating financial decision.
The way investment information is presented can influence myopic investors
A 2021 study titled "Effect of Uncertainty Visualizations on Myopic Loss Aversion and the Equity Premium Puzzle in Retirement Investment Decisions" explores how different ways of presenting investment information can influence these myopic tendencies.
Participants were asked to allocate funds between stocks and bonds over multiple periods, with each group viewing different types of visualizations to assess how different representations of investment outcomes might influence decision-making.
The visualizations included:
Bar Charts and Interval Plots:
Bar charts present discrete data points, often highlighting individual periods' performance, which can emphasize short-term volatility.
Interval plots show ranges within which future returns might fall but still focus on specific time frames.
These visualizations can lead investors to concentrate on short-term variability, reinforcing myopic loss aversion.
The study found that participants exposed to these charts tended to do what myopic investors do: play it overly safe and invest less in stocks.
Density and Cumulative Density Plots:
Density and cumulative density plots offer a more comprehensive view of potential investment outcomes.
Density plots illustrate the probability distribution of returns, providing insight into the likelihood of various outcomes over time.
Cumulative density plots show the aggregate probability of returns up to a certain point, helping investors understand the overall risk and reward possibilities.
These visualizations encourage a long-term perspective by emphasizing the distribution and cumulative probabilities of returns rather than short-term volatility.
The study found that participants who viewed these plots were more inclined to invest in stocks, recognizing the potential for higher long-term gains and displaying reduced myopic loss aversion.
What it means for you
The type of information you consume can influence how you invest your money.
If you don’t want to be a myopic investor, seek out information that focuses on the long-term benefits of investing—not the short-term volatility.
That means you probably want to delete the stock tracking app on your phone, unsubscribe from financial media that covers the daily drama of financial markets, and block finfluncers who want your attention.
Instead, look for information that focuses on the long-term benefits of investing and helps make you better understand how investing works.
This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any significant financial decisions.
Long-term is the way, Ben. Checking our portfolios every day makes us lose focus and stop seeing the big picture. Speaking from experience here.