By Joe Wiggins
The Curse of Short-Termism
In Chapter 12 of ‘The General Theory of Employment, Interest and Money’, John Maynard Keynes writes of the increasing short-term focus of investors, lamenting:
“Investment based on genuine long-term expectation is so difficult day to-day as to be scarcely practicable”.
Keynes’ seminal work was first published in 1936, so although it is easy to consider investor myopia as a modern phenomenon, it is not. Rather it is an ingrained feature of how humans engage with financial markets. That is not to say that the most pernicious problem faced by investors has not been exacerbated – the temptations are greater than ever – but simply that it is our default state. Unless we make a conscious effort to mitigate it, we will likely bear the heavy costs of short-termism.
The idea that adopting a long-term approach to investing can have a profound positive impact on our results can seem perverse. How can something so easy – doing less / paying less attention – lead to better outcomes? The critical misunderstanding here is the idea of simplicity. Long-termism is simple in theory but fiendishly difficult in practice. Everything from our psychological wiring to the broad environment in which we exist is dragging us toward making short-term choices. It takes considerable effort to extend our horizons.
Far from being easy, taking a long-term perspective is the most severe behavioural challenge that investors face.
Investing in the moment
Many of the decisions we make are a response to how we are feeling right now. Even when we think we are making a long-term choice, it is often a response to profound emotional stimulus. When we sell all of our risky assets in the teeth of a bear market we are relieving anxiety and fear – it feels good to do it at that moment. The cogent rationale we make for finally capitulating and buying stocks in the midst of a euphoric bubble is just a charade, what we are really doing is removing the stress and pressure of missing out. These types of feelings are smart from an evolutionary perspective – they helped us survive – they just make us terrible long-term investors.
It is not only our emotions and feelings that make us inveterate short-termists, but our inability to appropriately value long-term rewards. We are very poor at discounting and tend to give far more weight to near-term pay-offs than those that are stretched out far into the distance. We might be fully aware that staying invested is the best route to meeting our retirement goals thirty years hence, but the illusory lure of getting out of the market before the next crash might just prove too powerful.
Investing with a long-term mindset also requires us to ignore huge swathes of (potential) information. This is incredibly hard to do. We are being incessantly told that everything is changing, and we must respond to this by doing very little, which feels antithetical. A challenge exacerbated by the fact that what is happening in front of our eyes always feels like the most important thing. As Daniel Kahneman said:
“Nothing in life is as important as you think it is, while you are thinking of it”.
Taking a long-term approach means frequently ignoring issues that we and everyone believes – at that moment – are absolutely critical. No wonder so few investors can do it.
Short-term is the norm
As if our own psychological foibles are not enough, there is another factor that makes it worse. Much worse. The environment in which we make investment decisions.
Most people are wired in the same way we are. We all want short-term gratification, so the investment industry is set-up to provide it. It is incredibly difficult to build a business or a career by saying: “Just wait thirty years and you will be okay”. If we want to get a promotion or sell an investment, then we need to be seen to be doing something. That almost always means taking a short-term view. We are incentivised to survive, and waiting for the long-term to play out is akin to a death wish.
Short-termism is not some elaborate profiteering plot, although it can feel like it, it is just the prevailing and powerful norm in investing. Everyone cares about it and lives by it, so everyone has to adopt that approach and play the game. Try saying we didn’t trade this quarter or last month’s performance was irrelevant and see how far that gets us.
Nothing can stop us
If the Keynes quote at the beginning of this piece suggested that short-termism was nothing new, that is only partially true. There is a difference between our willingness and ability to be myopic. We were always willing but are now more able than ever.
There are two key elements that facilitate our short-termism. The amount of information available and the ease at which we can react to it. We are not inherently more short-term in our thinking than we used to be, but we are now faced with inescapable and overwhelming exposure to financial market noise – “7 seconds until the European market opens” – and can trade whenever we like. It is hard to think of a more toxic combination for provoking our worst investing behaviours.
Technological innovations have been wonderful for investors, and also a behavioural disaster, inflaming our ingrained short-term predilections.
Say a lot, do a little
Are there any solutions? There are some. Not checking our portfolios or switching off financial news are likely positive steps toward better investment outcomes. But perhaps they are unrealistic. A more powerful approach might be an attempt to separate words from action.
Financial markets are incredibly diverting; they capture our attention and we cannot reasonably ignore them. Discussing them, however, should be entirely separate from taking active investment decisions.
One of the reasons that there is so much unnecessary and costly trading on portfolios is because investors feel like they must have something to talk about with clients. Trading creates narratives which creates comfort. This plays to the notion that although tactical asset allocation doesn’t add value, it does help keep clients invested – because they feel happier that things are being looked after and it placates their desire to see short-term action.
Maybe this is inescapable, but if we want to enjoy the benefits of long-term investing, we need to find more ways of discussing financial markets without feeling compelled to constantly act.
A long-term approach is (almost) always better
There is no greater advantage available to any investor than taking a longer-term approach. There is one important caveat, however. Long-termism is a great idea on the proviso that we make sensible decisions at the start. They don’t have to be heroic, they needn’t be optimal and there is no requirement for genius. Just some sensible choices and a long horizon will leave us better placed than most.
That’s far easier said than done.
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