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The best response to the stock market’s whipsaws is to ignore them.
That’s easier said than done — and if ignoring the market’s volatility is impossible, you should turn off the financial news altogether.
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Counterintuitively, not only will you sleep more easily, your investment performance will likely improve as well. That’s according to a fascinating study of how investors’ behavior changes when they stop thinking short-term and see investments with a time horizon of more than 12 months.
The improvement in performance is significant: When spread over a hypothetical 35-year investment career, following this advice is projected to increase total retirement wealth by between 10% and 20%.
The study, “The Display of Information and Household Investment Behavior,” analyzed the impact of a regulatory change in Israel that required retirement funds to stop displaying performance over the recent past.
Prior to this change, one-month returns were prominently shown in fund communications with clients; after the change, only performance longer than 12 months was displayed. The study found that the change in reporting dramatically reduced investors’ reactivity to market volatility, and a corresponding increase in their willingness to invest in riskier funds.
Consider the U.S. stock market: If all you knew about the U.S. stock market over the past 12 months was that the S&P 500 SPX had gained 29.0%, the market’s volatility would be invisible. You’d likely be more inclined to not only stick with your current stock investments but possibly boost them as well.
Fundamentally, the study’s finding traces to the statistical tendency for volatility to be lower as the length of your observation period increases. So even when the stock market is falling, an investor who focuses only on returns over the next year will tend to have a higher equity allocation than another investor who focuses on the next month. That higher allocation should in turn produce a greater return over the long term.
What if you can’t resist paying attention to the news and the markets’ short-term volatility? Greek mythology provides guidance, specifically Homer’s epic poem “The Odyssey.” As Odysseus and his ship were sailing by the Sirens, he knew the Sirens’ song would be irresistible and — if he didn’t resist its allure — fatal. He instructed his crew to tie him to the ship’s mast of his ship so that he could listen and yet not succumb.
Today’s financial news is the investment equivalent of the Sirens’ song, so you need to figuratively tie yourself to the mast to avoid its allure. Explore what kind of defense actually works for you. But one approach that many investors find effective is to set up the management of their portfolios so that they can’t make a change without first discussing it with their financial adviser.
More: You can’t build financial security with a 90-day mindset. Why quarterly earnings reports hurt investors.
Also read: The government is meddling with earnings reporting — but Tesla, Amazon and other market superstars prove there’s no problem
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