Did you know that professionals managing the average Canadian pension plan manage with a time horizon of thirty years? Did you know that the average Canadian will make six moves in their lifetime. If we assume that our residential life expectancy is 50 years – i.e. we buy the first home at 25, and move up to a more expensive neighborhood and into a larger home until age 65, when we begin to look at downsizing – then we will make a move every ten years. 

These time lines are important, because they frame performance expectations. We know, for example, that the average Canadian believes that investments made by the professionals managing their pension plan will provide the expected income stream at retirement. We also know from studies, that the average Canadian believes that the best way to create personal wealth, is to buy real estate. 

In a sense Canadians are both right and wrong at the same time. They are right that wealth can be created through real estate. They are also correct to believe that most pensions will deliver the promised income at retirement. However, the assumption that real estate is the best way to create wealth, or that pension managers are always invested in the best assets, is wrong.

Now look at the flip side. Most investors believe that stocks are risky, and that the stock market is at best, a “crap shoot.” Those same people believe that Government of Canada bonds and Guaranteed Investment Certificates are risk free investments. And if you hold them to maturity, there really is no risk to principal. You will get back the money you originally invested plus some rate of interest. 

However, if we are to describe that as risk free then you are forgetting about the long term impact on purchasing power. If the long term rate of inflation is say 3% and your ten year Government of Canada bond yields 4%, then your real inflation adjusted rate of return is just 1% per annum. But those semi-annual interest payments which is where the 4% return comes from, is taxed as ordinary income. If you are in tax bracket higher than 25%, you are paying more than the 1% per annum real rate of return to the government. So, your real after tax return is less than the prevailing rate of inflation, which means that you are guaranteed to have a loss of purchasing power over the life of the investment. How important is that, and do you consider that a significant risk? 

The real question is whether investor expectations jive with the reality of the marketplace. Is real estate really a better investment or does it simply seem better because of the time line used to frame our expectations. Can we really make a value judgment about the performance of real estate versus stocks, if we are framing the results on one asset every ten years, versus a frame of reference for stocks that can be day to day. 

Take that a step further, and we see that stocks are liquid assets, real estate is not. By that we mean that stocks can be bought and sold on a moments notice. Selling real estate takes time. What’s interesting, is that there are serious implications to that. 

Ask someone what their home is worth, and the price quoted will depend on the mood of the homeowner. The value in the mind of the homeowner has no real value, unless a transaction actually occurs at that price. 

Because stocks are liquid, you have the ability to evaluate your position instantly with a market price that you can trade at. There is no way to fudge the value of your stock, because its price is clearly defined. Try looking at a stock position when it is falling in price. The more frequently you look at the position, the more distressed you become. A behavior known as myopic loss aversion. 

Once you get around the academic jargon used to describe investor behavior, you will note that each discussion point reflects something you have experienced in one form or another. What you need to recognize, is that each of these flawed actions are driven by emotions. Riding the emotional roller coaster will prevent you from achieving positive long term investment results. Making it harder to get where you want to go, from where you are now. 

Myopic loss aversion is a behavior related to the frequency at which you look at your investments. This behavior is wide spread, infecting all but the most disciplined investor. It is the foundation on which the financial media exists. Today there are television networks dedicated to round the clock coverage of financial news. The internet houses, as Dr. Carl Sagan might have put it when describing stars in the universe, billions and billions of financial websites. Try to find a mainstream newspaper without a section dedicated to financial news, not to mention the number of newspapers dedicated to just financial news. 

All of this attention focuses on short term micro events. Experts telling you why you should buy or sell a particular stock… today. Quarterly earnings numbers are dissected from every angle, and price the stock will move on the basis of a quarterly number that either fell short, met or exceeded expectations. Stocks prices can move dramatically if a company wins or loses a new contract, as if that were the only contract the company was involved in. When technology stocks were flying high, companies were announcing new contracts on a daily and sometimes hourly basis. All of them reported to an audience with an insatiable appetite for information. 

That is the “myopic” component of this behavior. The propensity to focus on specific events that affect specific securities or specific financial assets over short time periods. What makes this behavior harmful is that it often leads to a decision based on short term noise, with no regard to long term consequences. Investors sell because they should “cut their losses” or because “nobody was ever hurt taking a profit.” They buy now before its too late, because they do not want to “miss the opportunity.” Without ever questioning the long term implications of the event that lead to the decision. 

When you think about it, myopic loss aversion is the same behavior trait that is associated with weight loss. If you are on a diet, you frame your results on the basis of a “long term” goal with a set of shorter term expectations. The more frequently you step on the scale, the more likely it is you will become frustrated, leading to depression which ultimately leads to a return to the bad habits that caused the problem in the first place. Even if you are losing weight, it can be frustrating, because the amount of weight loss may not meet your expectations. 

Companies that market weight loss programs know this behavior. What makes their program successful has less to do with the diet, and more to do with managing expectations. In fact they will usually tell you to stay away from the scales, until the next meeting. They know that cutting the frequency of reviews, provides a time line that has a much better chance of delivering the results you are looking for. 

Same with investment planning. The longer the time frame, and the less often you review your investment portfolio, the better than chance that it will meet your expectations. 

Building a portfolio can go a long way towards thwarting your emotional responses, because it is more difficult to become emotionally attached to a group of assets, rather than a specific stock. One more reason, portfolios are the right solutions for long term investors.