The results may surprise you.
At least once a quarter for the last twenty years, I have received the same request, “Can you please make daily performance numbers available on your strategies?” This week yet another request was made.
This is despite the fact that we make daily account balances available here and on each platform’s website (TCA’s Liberty site, for example), our model account results are available on our website to financial advisors with daily return numbers provided with a five-day delay (to allow all trades and dividend payments to settle) and each week the hotline provides the weekly returns for all of our popular strategies.
Historically, I have not gone farther, first, because daily data has a higher incidence of mistakes even from the largest financial companies and these take time to be discovered and corrected. Why get worked up about something until it is verified?
Secondly, even professional investors have determined that for the most part daily data is too noisy to trade on the most popular technical analysis basis – momentum or trend following. More than twenty years ago we studied whether to use daily or weekly data in our trend approach – Evolution. Every way we studied it, it always came back the same. Daily data did worse than weekly. There was too much noise – random price movements, event, or headline spikes – to effectively discern the trend from daily data. When we did our FUSION research over the last two years, the results were the same.
Third, most investors have little interest in the daily data. While our daily account balance page is popular, less than 1% of our account holders go there daily.
Finally, and most importantly, I’ve always believed that watching account returns daily is bad for the average investor’s financial health. Why do I believe this? Because there is a substantial body of academic research that supports this belief.
There has been a wide array of academic studies of how often the average investor should look at their financial statements. While one should check account balances at least once a month to make sure nothing untoward has occurred (identity theft or custodian error, for example), calculating or reviewing returns is an entirely different matter. Most studies have shown that the best review period is about every 12 months (some have concluded as short as eight months and others as long as fourteen months).
Why not more often? Isn’t more, better? The reason researchers (including two Nobel Prize winners) have reached the opposite conclusion is because of two behavioral biases uncovered among humans that especially apply to investors.
First, investors are loss adverse. This means that investors have more fear of losses than the pleasure they derive from gains (about twice as much). As a result, they pay a premium in the unrealized gains lost from the fear induced by past losses.
We have been seeing this play out for the last five years right before our eyes in the stock market. The losses endured by investors in 2007-8, not to mention 2000-2, have caused many investors, professional and non-professional, to miss out on the current 100%-plus bull market. Just today on CNBC I heard a commentator saying he thought the next big move for stocks was going to be up because there is so much money on the sidelines that has missed the gains but now needs to find a way to get in to stocks to achieve better results to show by year end.
What does investor loss aversion have to do with how often an investor should review returns on a financial statement? It stems from another behavioral bias: narrow framing.
By narrow framing we mean that people tend to make decisions by looking for simple decisions that can be made one at a time in a series. In contrast, broad framing looks at a series of options and makes a single comprehensive decision after reviewing all of them. Studies show that broad framing will be superior or at least equal to the “one simple decision at a time” approach “in every case in which several decision are to be contemplated together.”
Applying this to investors, studies have found that they tend to look at investing trade by trade or review their returns over very short time periods. When you consider this along with their tendency to be overly concerned with losses, you can see why reviewing strategy returns too often can be costly.
In fact, one of those Nobel Prize winners, Daniel Kahneman, in his book, “Thinking Fast and Slow,” concludes:
The combination of loss aversion and narrow framing is a costly curse. Individual investors can avoid that curse, achieving the emotional benefits of broad framing while also saving time and agony, by reducing the frequency with which they check how well their investments are doing. Closely following daily fluctuations is a losing proposition, because the pain of the frequent small losses exceeds the pleasure of the equally frequent small gains. Once a quarter is enough, and may be more than enough for individual investors.
Kahneman offers additional advice to investors beyond less frequent return review. He says investors should learn to think like traders.
How do traders who are glued to the computer screens seeing an unending stream of gains and losses survive the stress and avoid the effects of loss aversion. They take a broader view and adopt an attitude of “you win a few and you lose a few” whenever deciding to accept a small risk.
Kahneman did caution that, while this attitude is used by experienced traders to shield themselves from the pain of losses, the use of it by individual investors is subject to some qualifications:
- It works when gambles are genuinely independent of each other;
- It works only when the possible loss does not cause you to worry about your total wealth; and
- It should not be applied to long shots.
Here’s another example not from investments: We have all read that statistically it makes no sense to have a low deductible on insurance or to sign up for extended warranties on products. Many people do it anyway.
Even among those more disciplined that might initially have a higher deductible and/or avoid those extended warranties, it often seems that just one loss will cause them to start signing up for the warranties and/or lowering their deductibles. Loss aversion and narrow framing are at work here and the trader’s attitude of “you win a few, lose a few” would be better for our financial health.
I know the first time I heard this phrase applied to investing it sounded a bit cavalier, but think about it; if you have a properly diversified portfolio, be it made up of strategies or asset classes, will one trade or one day’s return really have that big an effect on your total investments?
When you chose that portfolio, did you choose it based on the results the day before or, instead, over a much longer period? And when you chose each asset class or strategy, did you think that every one of them would be profitable every day? Every month? Every quarter? Probably not.
So why look at returns every day, or every month, or even every quarter? Why give in to the tendency to overly fear a loss causing you to miss opportunities?
When most of this research was done, the predominant “strategy” for investing was “buy and hold” investing. Yet, Kahneman and Richard Thaler, the other Nobel Prize winner behind much of this research, still firmly believed these principles applied. If, instead, your investments are being managed by an investment advisor that is already actively managing the investment portfolio on a day-to-day basis, aren’t these considerations even more applicable?
Furthermore, if they are following a strategy that demonstrates a statistical edge based on years of research, aren’t you paying them to adopt the trader’s attitude for you? Why overrule your previous, broadly-framed decision?
In the financial markets, the greatest risk remains to be headline risk – whether the Ukraine, ISIS, Ebola or the European Union slowdown, they all have the potential to send prices reeling within the narrow frame of a day or so. On a broader basis, we continue in a rising trend. Just Friday, the S&P 500 set a new all-time high over 2000. Our STF and Fusion Indexes hit new all-time highs as well and all but one (the most conservative) have topped the S&P 500 year to date. See discussion below.
Interest rates remain low, earnings reports have been solid, and sentiment is bullish but may be getting a bit bubbly. While September seasonality is negative, it is less so in years where the market is up year to date (except in the first few days of the month when it is still very negative).
Historically, the very long view has the average September top occurring at the end of the first week, more recent data suggests a top around mid-month. Supporting this is the fact that this month most of the Federal Reserve infusion of money will occur in the first half of the month as well. Finally, a substantial majority of the economic reports last week were better than expected.
All this suggests that it may be best to ignore the daily returns for now, or if you must watch, use the opportunity afforded by any weakness to reposition your portfolios and add more equity to your portfolio until we have a conclusive break in the long-term uptrend.
All the best,
PS – Our family lost a good and faithful friend this weekend. Our son David’s dog, Precious, who lived many years with us as well, passed away.
It is strange how a four-legged creature can mean so much to us two-legged humans. But they are so much a part of our lives. When my son had an extended illness, she comforted him – rarely leaving his side, and when he trekked to the far west, she accompanied my son and me on the cross country journey. Out in California, she was a friend to David before he made any others.
She was so intelligent. She could do the darn’dest things, but her specialty was doors. There was rarely a door that could confound her. Many service people would ask me as they left, “Did you know that dog can open doors?” On our trip out west, she refused to stay in the hotel room. We’d leave her in the room and each time she’d get out and beat us to the elevator! We finally learned to always get carryout.
Even though she’s lived with David in California for four years, I’ll miss her being there when I come to visit. But I know she is better off now. Last time I visited earlier this year she was thinner, grayer, and had to be helped up the stairs. The dog that raced around our home, opened every door, and taught the dogs she left behind to do it too is gone, but the memory lingers and hopefully won’t go away.