Investment is a long-term endeavour designed to meet our long-term financial objectives, so why do we spend so much of our time obsessing about the short-term and almost inevitably taking decisions that make us worse off?  Well, here are 50 reasons to start with:

1: Because it is boring.

2: Because markets are random and it’s difficult to accept.

3: Because of short-term benchmark comparisons.

4: Because we are remunerated based on annual performance.

5: Because of quarterly risk and performance reviews.

6: Because there is always something / somebody performing better.

7: Because we watch financial news.

8: Because we think we can time markets.

9: Because even good long-term investment decisions can have disappointing outcomes.

10: Because the fund we manage charges performance fees.

11: Because short-term losses are painful.

12: Because we forget about compounding.

13: Because we are obsessed with what is happening right now.

14: Because we are poor at discounting the future.

15: Because we will be in a different job in three years’ time.

16: Because we extrapolate recent trends.

17: Because we check our portfolios every day.

18: Because it is so easy to trade our portfolios.

19: Because we think poor short-term outcomes means that something is wrong.

20: Because we make decisions when we are emotional.

21: Because we think we can forecast economic developments.

22: Because we think that we know how markets will react to economic developments.

23: Because we compare our returns to the wrong things.

24: Because it is hard to do nothing.

25: Because regulations require that we must be notified after our investment falls by 10%.

26: Because it feels good to buy things that have been performing well.

27: Because there is too much information.

28: Because we don’t know what information matters.

29: Because we don’t want to lose our job.

30: Because nobody else is.

31: Because we need to justify our existence.

32: Because we think we are more skilful than we are.

33: Because we work for a listed company.

34: Because we don’t want to lose clients.

35: Because we think one year is long-term.

36: Because assets with high long-term return potential can be disappointing in the short term.

37: Because we think performance consistency is a real thing.

38: Because we don’t want to spend much of our time looking ‘wrong’.

39: Because the latest fad is alluring.

40: Because there is a new paradigm.

41: Because we vividly remember that short-term call we got right.

42: Because we can’t tell clients we haven’t been doing much.

43: Because we think we are better than other people.

44: Because we have to justify fees.

45: Because we don’t want to be invested through the next bear market.

46: Because we think short-term news is relevant to long-term returns.

47: Because short-term investing can be exciting.

48: Because we have to have an opinion.

49: Because there are so many experts and they are all so convincing.

50: Because it seems too simple.

Adopting a genuinely long-term approach to investment is one of the few genuine edges or advantages any investor can hope to exploit.  Unfortunately, it can feel as if everything is conspiring against our attempts to benefit from it – but that does not mean we should not try.

 

I would like to make clear at the outset that this post is not about the attractiveness of illiquid asset classes – I will leave others to debate the merits (and drawbacks) of private equity and its counterparts – rather I am interested in the behavioural implications of illiquidity. I was reminded of the idea about there being some form of behavioural premium for illiquid investments whilst listening to this discussion between Cliff Asness and Patrick O’Shaughnessy; I also briefly mentioned this notion in my post questioning whether volatility equated to risk.

What do I mean by a behavioural premium? Let’s assume there are two identical assets, but one offers daily liquidity and is market priced, and the other is appraisal priced / valued and provides liquidity on an annual basis. I would contend that, on average, investors are likely to be better off (from a return perspective) in the less liquid structure over the long-term because of the implications for our behaviour.

Most of the behavioural problems that plague investors stem from our reaction to the fluctuations in price of an asset allied to our ability to freely trade it. It is almost certain that many of the benefits investors have witnessed in recent years in terms of greater control and transparency have come with a behavioural cost[i].  Of course, these issues relate primarily to liquid, regularly traded, market priced assets; illiquid investments have different features – two of which are particularly important when considering the implications for our investment decision making.

– Price volatility is reduced: Illiquid assets are typically valued on some form of appraisal basis, rather through than market pricing. This does not remove price volatility entirely but should lead to a significantly smoother return profile. Although we can argue about whether volatility is an adequate measure of risk, it seems irrefutable that the variability in the price of an investment influences our behaviour.

Whilst the underlying risk of an asset is not altered by the manner or frequency with which it is valued, volatility does matter. Not only does it provoke our behavioural biases (such as myopic loss aversion[ii]); but volatility is the fuel that feeds the fire of narratives that dominate our investment decision making. If we observe or experience reduced volatility, we are less likely to act because of volatility.

– Ability to trade is removed or restricted:  It is simply more difficult (by definition) to trade illiquid assets. With a liquid, market priced asset there is the ability to react immediately – this can be costly, particularly if our decision making is emotion-laden[iii].

For most investors a few sensible decisions are all that is required to have solid long-term investment outcomes, however, daily liquidity and easy access to our investments means that we are forced to make investment decisions perpetually – is my asset allocation correct? What about the recent fall in value of my portfolio? Should I reduce my equity exposure as there might be a recession ahead? Market movements incite an often overwhelming temptation to act, which technology and liquidity facilitate, increasing the potential for behavioural mistakes. Illiquidity (indirectly) forces us to make fewer decisions, potentially reducing the behaviour gap.

Of course, the idea of a behavioural premium for illiquidity is something of an abstraction – liquid and illiquid assets are distinct and we cannot perfectly isolate the behavioural impact of investments with different liquidity profiles.  Furthermore, an investment should never be selected on the basis of its liquidity or pricing methodology.

Investors, however, don’t have to invest in illiquid assets to capture such a behavioural premium; rather we can create a similar benefit with liquid investments simply by taking steps to reduce evaluation and decision making frequency – through making it harder to trade (limiting investment decisions) and checking portfolios less regularly (to reduce our ‘experienced’ volatility).  In an era of improved technology and access such actions can feel at best simplistic and at worst retrograde, but are crucial in making and sticking with sensible long-term investment plans.

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[i] Hardin, A. M., & Looney, C. A. (2012). Myopic loss aversion: Demystifying the key factors influencing decision problem framing. Organizational Behavior and Human Decision Processes, 117(2), 311-331.

[ii] Benartzi, S., & Thaler, R. H. (1995). Myopic loss aversion and the equity premium puzzle. The quarterly journal of Economics, 110(1), 73-92.

[iii] Loewenstein, G., & Lerner, J. S. (2003). The role of affect in decision making. Handbook of affective science, 619(642), 3.