Active investment management’s weekly magazine for fee-based advisors

How often should you review your investment returns?

by | Apr 2, 2015 | UpClose

How often should you review your investment returns?

by | Apr 2, 2015 | UpClose

The results may surprise you.
In my position as president at Flexible Plan Investments, Ltd., at least once a quarter for the last 20 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 on our secure website and on each of our custodial partners’ websites. 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 our “Hotline” newsletter provides the weekly returns for all of our most popular strategies.

Historically, I have not gone further—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?

Second, 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 20 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 strategy research, the results were the same.

Third, most investors have little interest in the daily data. While our daily account balance page is popular, fewer 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 on 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 14 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.

Closely following daily fluctuations is a losing proposition, because the pain of frequent small losses exceeds the pleasure of equally frequent small gains.

First, investors are loss-averse. This means that for investors, the fear of loss is greater 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 six years right before our eyes in the stock market. The losses endured by investors in 2007-2008, not to mention 2000-2002, have caused many investors, professional or otherwise, to largely miss out on the current impressive bull market.

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 decisions 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 (emphasis on “small”).

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?

The combination of loss aversion and narrow framing is a costly curse.

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 and fall prey to “narrow framing”? It frankly makes little sense for advisors or their investor clients.

The opinions expressed in this article are those of the author and do not necessarily represent the views of Proactive Advisor Magazine. These opinions are presented for educational purposes only.


Jerry C. Wagner, founder and president of Flexible Plan Investments, Ltd. (FPI), is a leader in the active investment management industry. Since 1981, FPI has focused on preserving and growing capital through a robust active investment approach combined with risk management. FPI was named to the 2015 Financial Times 300 Top Advisers and the 2015 Inc. 5000 List of fastest-growing private U.S. companies.


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