Oct. 6, 2020
The pandemic shrank our horizons. We once travelled to foreign lands and explored cities with impunity. Now visiting friends and family has become challenging. Thanksgiving will be a lonely occasion this year.
The fear of infection hems us in and draws our attention to short-term needs. Planning for the long term takes a back seat when dealing with an infected world.
When it comes to investing, it is natural to focus on the short term during periods of uncertainty. A wave of anxiety crashed into the markets in March and another is threatening.
But don’t give in to fear. It is better to take a deep breath and pause to consider the long term. Think about the odds that an investment will be profitable over the fullness of time rather than how it will fare over the next few days and weeks.
I find reassurance when exploring probabilities derived from the historical record. For instance, I recently calculated the chance of making a profitable investment in the Canadian stock market, as represented by the S&P/TSX Composite Total Return Index, over various periods. (All of the probabilities herein are based on returns that include dividend reinvestment but do not include fund fees, trading frictions, taxes or inflation.)
If you had purchased the index at the close of a random day in the first three quarters of 2020, you’d have lost money by the close of the following trading day about 42 per cent of the time. Put more positively, the index would have climbed 58 per cent of the time. (I include the rare instances when the index didn’t change on the positive side of the ledger.)
The odds of a positive daily return were pretty good despite the market turmoil this year. But there’s a problem. The emotional impact of a bad result tends to greatly exceed that of a good one. A gain is discounted while a loss can loom large. The eye is drawn to the downside.
If you don’t believe me, track your portfolio’s gains and losses each day or – even worse – each hour. Your therapist will thank you for the extra business.
Most investors should track their portfolios much less frequently. Those who are patient can avoid the mental pain caused by short-term losses that tend to reverse themselves over the longer term.
The accompanying graph highlights the benefits of taking a longer-term view. It shows the probability of making a profitable investment in the market in the months following the investment. It also shows the chance of suffering from a loss. (The graph is based on month-end data from the end of January, 1956, to the end of September, 2020.)
For instance, if you bought the index at the end of a randomly selected month in the study period, there’s a 62-per-cent chance it climbed the following month. Conversely, you’d have lost money the other 38 per cent of the time.
The odds of a happy result increased over longer periods. If you checked in on the index every year, there was a 73-per-cent chance it was up over the prior year’s result. If you checked every two years, the chance of success climbed to 83 per cent. The chance of success shot up to 98 per cent by the five-year mark.
I’ll admit that checking on your portfolio once every five years isn’t practical. On the other hand, checking it every day is unwise for the vast majority of investors. On balance, index investors would likely benefit by checking on the performance of their well-structured low-fee portfolios perhaps once every year or two.
When life conspires to induce more frequent monitoring, try to focus on long-term returns rather than on those over the past month, day or hour. We’ve already suffered from an anxiety-inducing year. If you track your returns frequently, you’ll add to your stress level and might find yourself eating more pumpkin pie than usual this year.
This Globe and Mail article was legally licensed by AdvisorStream.