Is your smartphone making you a not-so-smart investor?
For many people, the answer is yes, for a simple reason: They tend to make investment decisions based on short-term losses in their portfolio, ignoring their long-term investment plan.
Behavioral economists call that tendency “myopic loss aversion”—and it can be incredibly costly.
For instance, some investors panicked and sold their stocks in the midst of the 2008 financial crisis, even though they weren’t planning to retire for a long time. The stock market, of course, has since roared back, with the S&P 500 index tripling in value since March 2009. The hope of every investor is to buy low and sell high. Myopic loss aversion causes us to do the opposite.
What does this have to do with your smartphone? The main trigger of myopic loss aversion is frequent feedback. When people are frequently told how their investments are doing—say, if they are given a daily update on their long-term investments, by smartphone or any other digital device—they are more likely to make poor financial decisions and possibly sell at the wrong time.
To understand why, consider what you’re likely to find if you monitor the S&P 500 index at different intervals. If you check every single day, there’s a roughly 47% chance that the market will have gone down, based on its past movements. But what happens if you check once a month? The numbers will start to look a little better, as the market will only have gone down 41% of the time. Years are better still, as the S&P generates a positive return seven years out of every 10. And if you check once a decade, then you’re only going to get bad news about 15% of the time.
There’s solid evidence that experiencing short-term losses—noticing that your portfolio is losing money—leads to poor choices.
In one lab experiment by professors Richard Thaler, Amos Tversky, Daniel Kahneman and Alan Schwartz, subjects were far more likely to invest in the safer option when feedback was given more frequently. Unfortunately, the safer investment also generated lower returns over the long haul.
As the researchers said, in a report published in the Quarterly Journal of Economics in 1997, “Providing such investors with frequent feedback about their outcomes is likely to encourage their worst tendencies. …More is not always better. The subjects with the most data did the worst in terms of money earned.”
This brings me to the digital world. Given the profusion of connected devices, I think most people will end up looking at their investment portfolio far more frequently in the 21st century than they ever have before. Over time, this abundance of feedback might make us more vulnerable to myopic loss aversion, since the more often you check the S&P 500, the more likely it is to have gone down. In other words, our investment horizon might shrink to reflect the frequency of feedback.
To be sure, I’m not making predictions about the future of the stock market: I have no idea what’s going to happen. But I do wonder if we might soon reach a point where investors who get a high frequency of feedback aren’t even willing to hold bonds, since bonds sometimes go down. They might insist on cash instead.
Seeing the big picture
While there is no cure for myopic loss aversion, there are some sensible steps we can take to reduce its impact. The first is to curate our digital world, ensuring that we aren’t inundated with feedback we don’t need. We should hide the stock app on our smartphones and avoid market updates on our smartwatches.
And when we do look at our portfolio, it’s important that we find ways to think about the bigger picture. Perhaps our 401(k) statement should highlight our projected income in retirement, and not the percentage gain or loss over the past year.
By helping people focus on the most meaningful variables of their financial lives, we can not only spare them unneeded worry, but also help them avoid costly investing mistakes.