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Michael D. Lam, Senior Editor for "The Horsesmouth" wrote an interesting article entitled, "A Painful Example of Short-Term Thinking." In it, he reviews and summarizes a new book, Fooled by Randomness - The Hidden Role of Chance in the Markets and in Life by Nassim Nicholas Taleb.
Lam believes that investors who pore over their portfolios every instant are only hurting themselves. Too much scrutiny causes investors to mistake volatility for returns - or, to use the language of communications theory - to confuse noise with information.
As a hypothetical example of how and why this happens, imagine a retired investor who spends his time tending his nest egg. Assume two things about the performance of his portfolio:
- He can expect a rate of return of 10% in excess of Treasury Bills.
- Annually, returns will vary by 8% from this average.
So by definition, over the long-term, the return should average 10%, but there will be years when the return actually dips to 2%. In fact, under extreme conditions (see returns for 2000 and 2001) the return could dip another 8% to -6%. So, even though the long-term return is 10%, the swings from year to year can be considerable.
The problem is, for short-term thinkers, randomness has some unexpected and somewhat shocking results. According to Lam's article, if the investor looks at his investments every day, he'll see a loss slightly less than half the time. If he reads only his monthly statements, however, he'll be pleasantly surprised two-thirds of the time. And, if he calculates his net worth only once a year, he'll be pleasantly surprised 19 out of 20 times.
If you consider that the pain of loss is more deeply felt than the thrill of equivalent gains (by 2 to 2.5 times), psychologists note our investor's high frequency review of his accounts would prove painful.
The moral of the story is to stay disciplined. Resist the lure of short-term thinking, which results in an over-investment of time, attention, and analysis in what is at best, strictly meaningless, or at worst, very detrimental to your portfolios.
©2010, Kelly Ruggles, Spokane, WA Web site
Kelly C. Ruggles, Spokane, WA is a fee-based financial planner located in Spokane.
Kelly C. Ruggles, Spokane, WA President of American Reliance Group, Inc., a registered investment advisor.
Kelly Ruggles, Spokane, WA is the author of "The Financial Playbook" for Retirement
Kelly C. Ruggles, Spokane, WA does not intend to provide personalized investment advice through this publication and does not represent the strategies or services discussed are suitable for any investor. Investors should consult with their financial advisors prior to making any investment decisions
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