Stoic Alpha: How Philosophy Can Help Rational Investors Stay The Course
Chapter 34 of The Rational Investor
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Trying to be a “great” investor is a self-defeating prophecy.
The rational investor knows that the more you tinker with your portfolio by picking individual stocks, selling stocks before an “inevitable” market crash, or getting into “alternative” assets, the worse your portfolio performs.
The data is clear on what happens to most investors who tinker.
They have no idea when to sell the individual stocks they bought.
They sit on the sidelines, waiting for that market crash that takes a lot longer than they ever imagined.
Then when the market finally does crash, they wait too long to get back in and miss some of the best days in the history of the stock market.
Their alternative investments underperform.
Most people would be better off simply sitting still and doing nothing through a market crash and recovery than tinkering with their portfolios ahead of time.
The more you do to avoid a bad investment outcome, the faster you bring about what you sought to avoid.
We are all myopic investors
A 1997 paper written by Richard Thaler Et al. discussed how myopic loss aversion impacts investors.1 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.