Short-Termism is Our Default Setting

It is often stated that the key to strong long-term investment performance is the ability to compound good short-term results. Although avoiding near-term disasters (such as severe permanent losses or extreme volatility) is imperative for all investors; the idea that an acute focus on the immediate future when managing our investments will lead to positive outcomes over long-run horizons is deeply flawed. There is a paradox at the heart of our investment behaviour whereby the more we care about what happens in the short-term, the worse our long-term performance is likely to be.

Although the precise definition of long and short-term investing horizons is somewhat hazy, let’s assume that short-term is under three years and long-term is over ten years (we can ignore the piece in the middle for now).

For most investors the core tenet of successful long-term investing is about making sensible, evidence-based decisions that put the odds on our side and then letting it play out. Although this sounds easy, it is far from it.

Whichever investment strategy we adopt, whichever funds or assets we hold, they won’t work every quarter, every year or even every three years. They will all go through spells of poor performance where negative narratives abound and our concerns will be pronounced. The temptation to change course will often prove overwhelming.

This is not about active versus passive investing. All approaches will come under scrutiny. We need only look at the number of obituaries being written for the 60/40 portfolio following an unusually difficult 2022. Investors of all churches will have to withstand periods of scrutiny and doubt in order to meet their long-run objectives.

The underlying problem is one of continually unhelpful feedback. Long-term investors receive constant feedback on their choices in terms of short-term performance and the narratives that accompany it. We perceive this to be meaningful information but it is nothing more than distracting noise.

Smart long-term investment decisions will often spend plenty of time looking like stupid ones. If we cannot endure this reality, we are likely to be drawn toward the dangerous allure of short-term performance chasing.

Trying to manage short-term performance is both exciting and exhausting. Exciting because we feel good about latching onto the latest fad or trend; exhausting because markets are fickle and unpredictable.

Caring about how we compare to others over the next quarter or next year will inevitably lead to poor outcomes. As we constantly chase our tail, predict the unpredictable, pursue grossly overplayed themes, buy at the peak, and sell at the trough.  

If such myopia is a sure route to poor results, why is it so prevalent? There are three primary factors at play:

1) It relieves stress and anxiety: Doing nothing for lengthy periods as a long-term investor is tough, particularly when we are receiving negative near-term feedback (our performance is disappointing). Making changes based on what is working right now makes us feel so much better.

2) We mistake short-term market noise for information: We are overwhelmed by a constant stream of data releases, opinions and, of course, fluctuating returns. The functioning of financial markets makes us believe that things are changing and that our portfolios must change as a consequence.

3) Our incentives are aligned with taking a short-term view: For professional investors, in particular, our incentives are almost inevitably aligned with adopting a short-term perspective. It is the safest way to build a career, stay busy and not lose our job / assets. People are happy with the short-term decisions we make as they will be pro-cyclical (buy the winners / sell the laggards) and we will have a story to tell. We won’t see the long-term costs because by the time they come to fruition we will most likely be in another job.

Aside from a select few who wish to dabble in short-term market timing (best of luck), the vast majority of investors would be better off in focusing on the long-term. Unfortunately, that is far easier said than done. Both our behavioural wiring and the febrile nature of financial markets makes short-termism our default setting. If we are going to be long-term investors, we need to have a plan for how we are going to do it.

My first book has just been published! The Intelligent Fund Investor explores the beliefs and behaviours that lead investors astray, and shows how we can make better decisions. You can get a copy here (UK) or here (US).