It’s easier than ever for investors to watch their money disappear.
The past couple of months have seen North American stock benchmarks exhibit incredible bouts of daily volatility, Friday being a prime example, as the Nasdaq Composite Index dipped by 3.5 per cent, while the S&P/TSX Composite Index lost 1.4 per cent. Peak-to-trough losses through the cycle have ranged from 11 per cent, in the case of the S&P/TSX, to 30 per cent for the Nasdaq.
For those with their nest eggs tied up in the stock market, that can mean gut-wrenching fluctuations in personal wealth on a daily basis. It can be difficult to look away, especially when brokerage platforms and mobile apps give users the ability to monitor their portfolios in real time.
But being too immersed in the daily turbulence of financial markets, and compulsively checking in on one’s own investments, can actually be detrimental to performance. Research consistently shows that excessive monitoring of short-term returns results in poorer outcomes over the long term.
“Divorcing yourself from all the noise is one of the most powerful things you can do as a long-term investor,” said Som Seif, chief executive officer of Purpose Investments.
For most people, investing does not seem to mesh well with their instincts toward risk and return. Putting a big chunk of one’s life’s savings on the line can feel unnatural, let alone in a vehicle as erratic and nebulous as the stock market.
But, of course, the stock market – in the broadest sense of the term – tends to rise in value over time. Over roughly the past century, the S&P 500 index has generated an average annual return of nearly 10 per cent.
As the time interval shrinks, the less certain a positive end result becomes. On any given day, the odds of the S&P 500 being in positive territory is basically a coin flip, according to an analysis by Washington-based money management firm Fisher Investments.
When moving from daily to monthly data, the frequency of positive returns rises to 63 per cent, Fisher found when looking at market results going back to the 1920s. Calendar year returns, meanwhile, were positive 74 per cent of the time. And by the time the investment horizon increased to 16 years, the U.S. stock market had a positive result 100 per cent of the time.
The more you zoom out, the more the stock market’s ups and downs give way to a smooth upward trajectory. By extension, those who monitor their own investments less frequently can spare themselves a great deal of emotional anguish.
People hate losing money, much more so than the pleasure they derive from an equivalent gain. This is the basis of prospect theory, which won psychologists Daniel Kahneman and Amos Tversky a Nobel prize in 2002.
Consider a pair of wild trading days from early May, when financial markets were in convulsions over the inflation threat and what central bankers might have to do to conquer it.
On May 4, the S&P 500 rose by 3 per cent – a huge single day move. The very next day, those gains were erased as the index dove by 3.6 per cent. The net effect was essentially zero. But investors who followed along were likely to end up feeling worse off for having lost the money they gained the day before.
Amplified over the course of a year or longer, the stock market can inflict an emotional toll on those who are paying the closest attention. Prof. Kahneman and Prof. Tversky later revisited their theory to see how loss aversion affected investor returns.
“The investors who got the most frequent feedback (and thus the most information) took the least risk and earned the least money,” they wrote.
A study conducted by U.S. robo-adviser SigFig found that its investors who checked in on their portfolios every day earned 0.2 per cent less each year in return than the average. Twice-a-day logins doubled the performance gap.
The effect seems to be magnified in moments of markets stress. Most investors can take a 10-per-cent correction in stride. But as portfolio losses start pushing 20 per cent, they start to lose their composure.
“The emotional pain starts to get exponentially larger,” said Preet Banerjee, a Toronto-based personal finance consultant. “That’s when the question creeps in, ‘Is this time different?’”
At times, the worst-case scenario can seem perilously close – the potential collapse of the global financial system, a depression resulting from a once-in-a-century pandemic, or the worst inflation in four decades spiralling out of control.
But the market is a proven compounding machine. Given enough time, it always bounces back. But not for those who let their emotions get the best of them when the chips are down.
“You go into sell mode, that’s the thing that truly destroys wealth, more than the markets going down,” Mr. Seif said.
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