Behavioral Finance

Neurosis Is Killing Your Returns!

Short-term volatility is the psychological price investors pay to achieve stocks’ high historical long-term returns.

When it comes to achieving the stock market’s long-term return, everyone pays. But you have a choice in how to remunerate. When turbulence hits you can either tough it out (a psychological cost), or you can hedge, trade or take some other action (an explicit cost).

The former (again, for long-term investing) is difficult to do but, in my view, optimal for your financial well-being. The second is flat-out neurotic and takes a good solid whack out of your future compounded returns.

Neurosis is common as air in humans—it is the anxiety-based, stress-induced, often compulsive counterproductive behavior manifesting from the inability to cope with one’s environment. That is about as spot-on a definition for malapropos investing activity as I can conjure. But, for whatever reason, when we study economics and finance we feel forced to use terms like “myopic loss aversion” when simple neurosis will do.

And chief among the neurosis activators: volatility. Folks obsess over it, and it breeds a litany of nonsensical behaviors. When long-term investors react to short-term noise and volatility, it is explicitly neurotic because it is a coping—not a strategy, not a bias, but a coping—behavior. One offending the goal of capturing stocks’ long-term return.

Consider how most think about volatility and how news is presented: as a short-term phenomenon. But the truth is volatility is vastly and meaningfully different across spans of time. And people love to quip that the long-term is made up of many short-terms. But that isn’t exactly right. In the short term, stocks zig and zag all over the place, swinging far more than bonds. But, since 1926, stocks rose in 94.1% of rolling 10-year periods—and by a wide magnitude more than bonds.[i] 94% positive is a statement of consistency and one-sidedness that blows the hinges off short-sighted volatility neurosis and renders the huge majority of urgent news flow entirely useless.

Here is the real question: Can you pay the psychic toll the market imposes? Do you want to? The raw, unfortunate truth of all this is that not all humans are equally able to cope with market volatility, which means many need help. So how do we cope? The compounded cost of frequently changing your plan, jumping in and out of stocks, paying up to hedge, “protect,” or—my favorite neurotic activity of all—“keep some dry powder available,” over time likely prevents us from achieving stocks’ long-term return. That is a wallop big as any bear—a demon within our own minds.

One of the best coping mechanisms I have ever fathomed is to find a trusted advisor who isn’t as emotionally involved in your own money, but who will put your interests first. Someone willing and able to build a long relationship with you, offering education, support and advice. In the long haul, that is worth many magnitudes more than a psychoanalyst’s couch or hedge against worries of the day.

In all things psychological, everyone pays. The market is no exception. Just as a healthy mind requires the upfront, deliberate and persistent payment of confronting the problems and issues in one’s life to maintain order, meaning and stability, so it is with investing. When we can’t cope with life, neurosis manifests; when we can’t cope with markets, we hedge.

That so many folks out there have fairly long time horizons but obsess over short-term volatility means risk, at least in this sense, is not empirical. It isn’t some number or thing out there—it is explicitly psychological. It is you—you are the risk. Before you look elsewhere, look inward. Stop the neurotic behavior. Your portfolio should thank you.



[i] Source: Global Financial Data, as of 12/31/2017. S&P 500 rolling 10-year total return (calculated using monthly data), December 1925 – December 2017.

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