The most influential aspect of investment decision making is our time horizon. By understanding the period over which we hope to invest we can better frame what we are trying to accomplish and how we might achieve it. If we are not certain about what the potential duration of our investment is, then we cannot hope to have a clear rationale for making it. Owning equities for three months bears little relationship with doing so over thirty years. Time is the defining feature.
Understanding our time horizon is far more difficult than it seems. It is not simply about a discrete start and end point. What comes in-between can be far more important. To recognise our true time horizon, we need to consider three elements: Our objective, our interactions, and our activity.
Our Objective: This seems like the easy part. I can gauge my time horizon by simply understanding the main goal of my investment. If it is for my pension it might be my retirement in 30 years. If I am a portfolio manager, it might be the five years stated in my fund’s prospectus. If I am taking a punt on a stock it might be a month.
Unfortunately, it is not quite so simple. There can be a sharp disconnect between our explicit and implicit investment objectives. Let’s take the fund manager. Their formal fund objective states a time horizon of five years, but their remuneration is based on returns over one year. They have also been going through a difficult period of performance and both their manager and clients are focused on the next quarter’s results. Over what time horizon are they now making decisions?
Even in the case of the personal pension, the 30-year goal creates a theoretical time horizon, but not necessarily a practical one. If I fill my pension with the latest flavour of the month thematic funds; I am not thinking about three decades hence, I am trying to turn a healthy profit over the next year. Our ability to assume more investment risk when we have a long-term investment objective can easily be used as a licence to make a succession of ill-judged, shorter-term decisions. Assuming exactly the wrong sort of risks.
The time horizon that stems from our investment objectives is about the specific incentives and pressures driving our decision. Can we identify the major motivating factors?
Our Interactions: Another critical aspect of our time horizon is the way in which we interact with our investments. How frequently do we check performance? How regularly do we review our decision? We can think of our time horizon as a start and end punctuated with a mini horizon whenever we interact. At each moment we do it we are generating a decision point. A situation where we will consciously or sub-consciously be making a judgement about whether to persist. Every interaction we have with our investments is creating the potential for us to obstruct the power of compounding.
Whenever we make changes to our investments it is because we think we are wrong about something. There is a better stock, a better fund, a better opportunity, a better time. Irrespective of how good our decisions are, the market will persistently lure us away from charting a sensible course. The more we engage, the more likely we are to succumb to its siren song.
Minimizing interactions is probably the sternest challenge faced by investors. Rather than being viewed as behaviourally prudent, restricting the amount we check our investments and markets is more likely to be seen as negligent. This is the curse of professional investors who are required to persistently evaluate and take action irrespective of whether it is likely to beneficial. Fixing short-term problems by incurring long-term costs.
Restricting interactions with our investments is not about making one decision and then closing our eyes and ears; nor does it mean failing to review and reassess the choices we have made. It is simply about understanding the behavioural reality that the more we interact, the shorter our time horizons are likely to become. We need to engage in a measured and deliberate fashion over time horizons that matter to us.
Our Activity: Frequent interaction with our investments raises the probability of increased trading and turnover, but it is not a certainty. The final element to consider is our activity. We can only act if we are able to. Worrying about quarterly performance and checking our investments everyday is irrelevant if it is impossible or difficult for us to trade. Our time horizon is also shaped by our ability to act. If we are locked into an investment for ten years, then that is our time horizon (the real illiquidity premium)!
Most of our investments are not fixed term; they are second-by-second, day-by day-liquid. We can, however, extend our horizons by adding friction. Slowing the decision-making process to extend our horizons or dulling the temptations fostered by our frequent interactions with markets. Professional investors might do this by using (dreaded) committees or creating specific hurdles to clear before a decision can be implemented. For private investors, the challenge is to marry the accessibility provided by technology with realism about our behaviour. Nudges that encourage long-term investing by making it more difficult to trade should be considered. It is an unfortunate truth that the best chance of long-term compounding in our investments might come with that forgotten pension that we had with a company we worked for ten years ago, rather than the current one which we are poring over each day.
If our horizons are short then having a constant option to quit or change course is invaluable, if we are long-term investors then it is an impediment. Our ability to act can frame and influence our time horizon.
Our investment time horizon is not a choice but an aspiration. If we don’t understand and align our objectives, interactions and activity then our behaviour is likely to be wildly inconsistent with what we are hoping to achieve.