Should retirees override their short-term loss aversion?

A new study looks at how one reporting tweak changes investor behaviour

Should retirees override their short-term loss aversion?

Good things come to those who wait, they say. But when it comes to investment returns, the wait can be agonizing; things are far more likely to get worse before they get better. In the meantime, those who check their portfolios on a weekly or monthly basis become too anxious to wait for short-term losses to cancel themselves out.

Combine the desire to avoid loss and the need to monitor your investments frequently, and you have Myopic Loss Aversion. The phenomenon’s existence has been supported by laboratory studies, but that’s changed thanks to a 2010 regulatory change in Israel prohibiting mutual-fund firms from reporting returns over any period under 12 months.

“Before the change, one-month returns were prominently reported in brokerage statements,” wrote MarketWatch columnist Mark Hulbert. “This new regulation gave researchers a tailor-made opportunity to see how this change would affect investment behaviour.”

Citing research from Maya Shaton, an economist in the Banking and Financial Analysis section of the Federal Reserve, he said that the change in reporting regulation “caused reduction in fund flow sensitivity to past returns, decline in trade volume, and increased asset allocation to riskier funds.”

Hulbert noted that over the observed time frame, Israeli investors on aggregate didn’t change their risk preferences. The only variable was the fact that they stopped seeing one-month returns, and that changed their perception of risk. “That seemingly insignificant change led to a dramatic change in their investment behaviour,” he said.

In other words, decreasing investors’ exposure to short-term noise could increase their willingness to accept risk, therefore increasing their chances of getting long-term positive returns. With that in mind, Hulbert said, retirees that already have a solid financial plan that caters to their financial situation and long-term goals may be better off ignoring the markets’ daily, weekly, and monthly gyrations.

“Only if you have discovered how to resist the allure of constantly making portfolio changes can you safely listen to the investment arena’s Sirens—CNBC and other sources of saturation coverage,” he said. “But even if you truly are one of the rare investors who can resist, ask yourself: If you’re not going to make any changes to your portfolio anyway, why bother with the saturation coverage?”