Tuesday, October 12, 2010

The dangers of reviewing your portfolio too often

Dan Richards

Reporter

For most of the past 200 years, the biggest challenge for investors was having too little information on which to base decisions.

As recently as 2000, for example, investors flocked to weekend investing forums for brochures and answers to basic questions.

In a remarkably short space of time, the Internet has changed everything. We’ve gone from starving for information to drowning in it – and everyone needs to put new strategies in place to deal with today’s information glut.

The first step is to pick where you’re going to focus your decision making. In her book The Art of Choosing, Sheena Iyengar of Columbia University talks about choice overload, the stress this creates and the need to be selective about the areas in which we make choices – in other words to be “choosy about choosing.”

Once you’ve decided where to make choices, the next decision relates to your sources of information.

The Internet provides a platform for those with fringe views. Poke around the Net a bit and you can find someone to support almost any view, no matter how extreme. Insofar as this opens the door to healthy debate, that’s good. But to the extent that it adds to the roar of information that overwhelms us, it’s unproductive, unhealthy and can damage the quality of decisions.

In the area of investing, you need to pick sources you trust and stick to them. We simply don’t have the means to validate all the information that crosses our computer screen.

To make good decisions, you must be discerning about who screens your information, relying on proven sources that have a strong track record and no hidden agendas. Watch out, however, for what academics call “confirmation bias” – selecting information that supports your point of view. You need to ensure you’re getting a broad range of views.

The next challenge for investors is picking the frequency with which to review accounts.

In a recent conversation with a retiree, he told me that he looks at his portfolio over coffee each morning. He doesn’t do anything as a result, he just looks at it because he can. If his portfolio is up, he feels a bit better; if it’s down, he feels worse.

In fact, many investors would be better off if they looked at their portfolios less often.

Brandes Investment Partners, the fund company, has recently done work based on insights from the Nobel prize winner Daniel Kahneman, known for his work on “prospect theory.” This theory demonstrates that investors feel losses twice as much as they do gains. As a result, the stress of losses can cause emotions to kick in and make investors abandon investments, even ones they intended to hang on to for the long term.

In his book, Fooled by Randomness, the mathematician and former trader Nicholas Taleb applied this theory to a portfolio that returns 15 per cent annually over 20 years, with 10 per cent volatility along the way. He calculated that someone with this portfolio would stand a 7-per-cent chance of losing money over the course of any given year, a 23-per-cent chance of losing money in a quarter, a 33-per-cent chance of losing money in a month, a 46-per-cent chance of losing money during a day and a 50-per-cent chance of losing money in any hour.

As a result, the more often you look at your portfolio, the more often you’re going to experience the stress of seeing a loss – even though that loss is likely to be transitory. The stress can skew your decisions.

Every study that’s compared the performance of investments to the performance of investors who own them shows that investors’ portfolios do much worse over the long run than the investments they hold at any single moment. The reason? Investors allow emotions to rule. As a result, they buy and sell at exactly the wrong time.

Warren Buffett put it well: “Success in investing doesn’t correlate with IQ, once you’re above the level of 125. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other investors in trouble.”

Counterintuitive as it might seem, many investors would be better off if they reduced the frequency with which they looked at their portfolios to quarterly if possible, monthly at most. By doing this, chances are that investors would improve their stress level, decision making and long-term performance.

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