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.

—

My first book has 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).

One of the most profound problems encountered by investors is deciding what matters. We are faced with an incessant barrage of noise and must somehow parse relevant information from it; it’s like attempting to quench our thirst from a fire hydrant.

The oscillations of financial markets make us obsess over what matters right now: Why did the stock market lose 1.2% today? What is the Fed going to do at its next meeting? What are the major themes that will define markets over the next three years? This carousel of explanation and prediction is the lifeblood of the investment industry. It writes stories, it sells, it creates jobs, it shifts allocations. It constantly tells us what we need to get right in order to meet our goals.

As soon as you step into this world it is easy to be captured by this vortex – if we don’t care about the same things that everyone else does, then we are an outlier. Everyone is talking about (insert topic of the day) so we must be interested and have an opinion. If we want to be part of the game, maybe we just have to play it.   

Or maybe not.  

Focusing on the wrong things is not only exhausting, but it encourages the worst of our investing behaviours – what we think is an effort to add value is very likely to be destroying it. Instead of engaging in the search for the next critical fragment of information or attempting to predict, with high confidence, the next meaningful variable, we should take a different approach and ask – what really matters? 

For it to matter to us, there are two questions we should always ask ourselves about a variable or piece of information we are considering:

– How influential is it likely to be in meeting my objective?

– How knowable or predictable is it?

For information to matter to enough for us to take an explicit view on it, we need two things to hold – we must be confident that it will impact the outcome we are seeking (usually returns) and be comfortable that either the information is already available, or we can accurately forecast it.

Let’s take some examples. Imagine we believe that the level of real yields will be influential for equity returns over the next three years; it is not sufficient to consider it an important variable, we need to believe that we can predict it with a reasonable level of confidence. If we assume that we cannot do this, then the level of real yields is not something that matters enough for us to take a high conviction view on – aside from being appropriately diversified across a range of potential outcomes.

Now assume we are a long-term (10 years +) investor and believe that valuation will be a key determinant of returns over our time horizon. In this scenario, both questions can be answered in the affirmative. The price we pay for an asset is more influential for the long-term returns we receive than anything else, and we know it with reasonable confidence in advance.

There is a caveat, however. If, in the valuation example, we contracted our time horizon – let’s say to one year – valuations would fail the test; although they are knowable, they are just not that influential over the short-run. Being clear about precisely what we are trying to achieve is critical in defining what should matter to our decision making.

The reason that short-term market predictions are so difficult to make is that we do not know what the most influential variables are likely to be (what market participants will care about tomorrow), nor – by definition – can we predict them. For short-term market forecasts everything and nothing matters.

For most investors there are two types of variables, dull and predictable ones (valuation, time horizons etc…) which always tend to matter over the long-run, and exciting and volatile ones, which tend to receive all the attention. This is understandable. Unpredictable variables are changeable, exciting and dominate our thinking. They allow us to weave compelling narratives and express distinctive views. It is hard to forge a career focusing on what everyone already knows and ignoring what everyone is talking about.

A huge host of things influence the short-term price movements in markets and this creates profound behavioural challenges; inevitably leading to erratic decision making and a loss of attention on what is important. A key first principle for all investors should be to define at the outset what factors matter most for us given our objectives. If we focus on these, it might just give us a fighting chance of cancelling out the noise.

—

My first book has 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).

Whether it is a simple extension being built on a house or the bold development of a brand-new railway line, we know two things: both projects will take longer to complete than estimated and will cost more (often a lot more) than budgeted. In How Big Things Get Done, Bent Flyvbjerg – one of the world’s leading experts on megaprojects – and Dan Gardner explore the somewhat puzzling phenomenon of repeated cost and time overruns, and explain how projects can be improved. Although the complex construction of a bridge may seem poles apart from the (relative) simplicity of making an investment decision; they both share a stark vulnerability to the foibles of human decision making. They can both fail in similar ways. What can investors learn from how projects go awry?

It is obvious to see when a project goes wrong – we start with a set of expectations about the finished product, how much it will cost and how long it will take, and those are either met or not. For investment decisions things are a little trickier – good choices can have bad outcomes (and vice-versa). The randomness and noise in financial markets means that we cannot call every decision that fails to outperform or meet it target a failure.

Let’s take an example. Imagine I invest my entire portfolio in a niche thematic fund that has already produced startling returns and holds assets with stratospheric valuations. Over the next three years its ascent continues and it trounces the broader market. Does that mean it was a good decision? No, it was a terrible one, just extraordinarily lucky.

So, if a failed investment decision is not necessarily one where performance disappoints, what is it? One where the odds of success at the point we make the choice are poor. Bad investment decisions can often be seen from the very start. The same can often be said for large projects.

Psychology and Power

Flyvbjerg and Gardner identify two “universal drivers” that separate a successful project from a flop – psychology and power. Investors should be well-versed in the challenges of making good choices whilst battling our behavioural biases. Any decision-making process – whether it be for an investment or project – that does not explicitly attempt to address these is destined for trouble.

While the influence of power seems obvious for major projects – politicians attempting to impact outcomes to suit their personal agenda – it can seem an irrelevance for investors, but it matters. This is particularly true of institutions that can make investment decisions that are tainted by ambitions, hierarchies and misaligned incentives.

The problem of psychology and power is not just that they can dramatically impact the decisions that we make; it is that they are unspoken. Few people would admit that an investment was driven more by our psychology than our analysis, and nobody would ever say that politics played a part. If we don’t acknowledge it, we cannot do anything about it.

Think Slow, Act Fast

One of the foundations of successful projects, according to Flyvbjerg and Gardner, is the ability to “think slow, act fast”. The basic premise is that we should take our time in diligent planning, as getting the planning right dramatically improves the accuracy and speed of the subsequent work. Far better to find problems in the planning stage, than deal with them halfway through a project.

The difficulty is that planning has a stigma attached to it. People want to see action not spreadsheets and PowerPoints, so there is an allure to getting started. Action trumps thinking. Not only this, but individuals with a vested interest in a particular project are also keen to see shovels in the ground – they know that once costs become sunk and commitment is entrenched the ability to turn back is severely compromised.

Acting in haste and repenting at leisure is undoubtedly also a behavioural issue for investors. The nature of financial markets – the stories, the trends, the performance obsession – almost compels us to act immediately. Either we have no particular plan in place, or emotions ride roughshod over the plan we thought we were going to follow. So we act in the moment.

Most investors really don’t need to be acting fast, but if we do it should only be when following a prudent plan of action which is aligned with our goals.     

Why – at the start, middle and end

A common pitfall identified by Flyvbjerg and Gardner in major project work is losing sight of reason it was undertaken in the first place. A project should start with an understanding of why it is being carried out, and that should remain at the forefront of all decision making throughout. It is incredibly easy to imagine how large and time-consuming projects become so complex that everybody involved forgets what they were actually trying to achieve at the start.

Investors can easily forget what the purpose of their investment decisions are. We might begin with a plan to save regularly over 30 years to fund our retirement. Yet three years down the line we are revamping our portfolio because it underperformed the market over the past six months, or because of an article we saw in the weekend newspapers. Living our portfolios day to day, week to week can easily lead to us forgetting the reason that we began investing.

What’s the reference class?

An area where major projects and investment decisions share identical failings is a lack of willingness to understand appropriate reference classes. We tend to think that the situation we face is distinct – nobody has ever built a bridge like this before / this fund manager is uniquely talented. This is the ‘inside view’, where we obsess over the specifics of our circumstance and ignore the lessons that we might learn from the ‘outside view’ – a wide reference class of similar scenarios.  

This is the reason why very few people adjust expectations for the work being undertaken on their house despite being aware of the cost and time overruns suffered by everyone else. It is the same reason people flock to star fund managers despite the poor record of these types of investments (high level of assets / expensive valuations / unsustainable performance). We seemingly cannot help but think that the precise information that pertains to our case is far more valuable than general comparators.

Reference class / outside view thinking is quite dull, we lose the attractions of the compelling narrative and replace them with some dry probabilities. Yet for investing and major project management, dull is likely to win out.  

A failure to learn

Perhaps the real unifying feature of troubled major projects and poor investment decisions is that despite seeing them all around us we don’t learn the lessons. In both cases this is driven by an unwillingness to accept and address the realities of our behaviour, so we keep repeating the same mistakes.

—

https://www.amazon.co.uk/How-Big-Things-Get-Done/dp/1035018934

—
My first book has 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).