Doing This 1 Thing Can Help You Avoid Costly Investment Mistakes

My U.S. colleague Morgan Housel once relayed this funny story about BlackRock chief executive Larry Fink:

“[Once, Fink was] having dinner with the manager of one of the world’s largest sovereign wealth funds. The fund’s objectives, the manager said, were generational. “So how do you measure performance?” Fink asked.

“Quarterly,” said the manager.”

Now, go on and laugh about it (I certainly chuckled when I first came across the story). But individual investors tend to fall into the same trap as well. When most people invest, it’s likely for the sake of some longer-term goal. It could be for a child’s university education, a comfortable retirement, a dream vacation, or to pay down a housing loan – really, it could be anything that is years down the road.

But with this as a backdrop, most individual investors then do something incredibly odd – they follow the daily movements of their investments. Although it might seem innocuous for us to scrutinise short-term movements in share prices, it can actually cause us to make costly investment mistakes.

I was reminded of this when I read my colleague John Reeves’ recent article about investing insights he gleaned from renowned psychologist Daniel Kahneman’s classic book, Thinking, Fast and Slow. Kahneman, despite being a psychologist, had won a Nobel Prize in economics in 2002.

In John’s article, he quoted the following from Kahneman’s book:

“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 for individual investors. In addition to improving the emotional quality of life, the deliberate avoidance of exposure to short-term outcomes improves the quality of both decisions and outcomes.”

A behavioural quirk in humans called loss aversion is partly responsible for this phenomenon. As humans, we’re hardwired to hate losses, more so than we love gains. This thus creates the potential for us to make sub-optimal decisions for our investing activities if we’re constantly barraged by short-term losses in the market. And unfortunately, it’s incredibly easy for the market to subject investors to “frequent small losses.”

We can look at the experience of the SPDR STI ETF (SGX: ES3) for a taste of what I mean. The exchange-traded fund, which tracks Singapore’s market barometer the Straits Times Index (SGX: ^STI), has achieved a modest gain of 7.6% from 30 January 2007 to 25 November 2014. But in that period of 1986 trading days, the SPDR STI ETF actually clocked losses in 790 of them – that’s some 40% of the time when investors would face losses.

Even investors in a long-term winner like Raffles Medical Group Ltd (SGX: R01) also had to sit through umpteen daily losses. In the same period as with the SPDR STI ETF above, Raffles Medical’s shares had gained some 274% in price to S$3.87. And yet, the company too saw its shares clock a daily loss 40% of the time.

A Fool’s take

In Kahneman’s quote above, he offered the one thing we investors should do to help reduce our chances of making poor decisions – and that is to not pay attention to daily fluctuations. Given the ubiquity of frequent short-term losses in shares (in the context of clocking long-term gains) and the harmful psychological effects they can cause, that’s sound advice from the Nobel Prize winner.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing ownns shares in Raffles Medical Group.