It’s a question I have asked many times over: if long-term investing works, why do investors fail to focus on the long-term?
The answer continues to both fascinate and surprise me.
History has shown time and again that long-term investing works, and is a suitable strategy for many risk-averse investors.
And yet, time and again, investors continue to fall prey to short-term thinking.
They are either unable to control their immediate impulses or abandon the idea of long-term investing for short-term, immediate rewards.
As investors attempt to jump in and out under the guise of maximising their returns, these frequent interruptions end up disrupting the long-term compounding process, leading missed opportunities with added trading costs.
There could be several reasons as to why people behave this way, and I would like to highlight three of them here. I also offer advice on how to counteract the negative effects of these emotional and mental shortcuts.
Impactful recent events
Our brain tends to disproportionately influenced by recent events.
Meanwhile, past events tend to fade into the background and get hidden within the dark recesses of our complex minds.
The Covid-19 virus outbreak is a great example of this effect, and is known as “recency bias”. In other words, our brains react to what’s happening at the moment and blows it up into a much larger issue than it may actually be.
Case to point: who can recall the USA-China trade war that broke out in 2018?
This event seems to have become a distant memory that’s been overtaken by incessant news on the virus and how many people it has sickened.
And remember the time when the Hong Kong riots and protests made front-page news? Today, this event is hardly even mentioned anymore.
Recency bias causes us to place undue weight on the most recent events and may cause investors to lose focus on what’s important — the long-term prospects and business growth of their underlying investments.
The wrong emotional triggers
As humans, we rely on a whole list of mental shortcuts in order to function normally in our everyday life. These serve to protect us from danger.
However, the same tendency may do us more harm than good when it comes to evaluating our investments.
Another behavioural fallacy is the availability heuristic, a shortcut that makes us rely on examples that are immediately available in order to make decisions or evaluate issues.
This shortcut can end up providing us with erroneous information.
Right now, the constant news on the virus outbreak can make it loom large in our minds, and the availability of data relating to such diseases makes them seem to occur much more commonly than what history may suggest.
As investors, we may get completely scared out of investing if we rely on available information about viruses to determine our investment decision-making.
The way to counter this is to look at events in perspective, and not just to rely on what’s readily available.
By doing a simple search on the frequency of occurrence of viral outbreaks, and studying the after-effects of them, an investor then gains a more all-rounded picture of what to expect, and avoids over-reliance on just a few silent “triggers”.
Hard-wired, flight to safety
The third aspect that distracts investors from the long-term is known as risk aversion or the “flight response”.
Risk aversion occurs when an investor has suffered losses on his portfolio and would trigger an immediate reaction that tells the mind to “run to safety”.
This reaction may serve us well if we are facing danger from a predator back during our caveman days. But today, it is hardly an appropriate response when faced with temporary losses.
When investors are confronted with losses, it’s hard to keep their minds focused on the long-term, as the brain continues to send messages that tell us to remove the source of this “pain”.
Get Smart: Fighting our base instincts
Fighting against the above mental shortcuts and biases is like fighting against our own basic instincts.
It may be tough but it is not impossible to do so once we are aware of their negative effects on our long-term wealth building.
The important thing here is to be aware of them so that we can learn how to manage and handle the emotions that inevitably come along.
Only then can we truly learn to focus on the long-term and shut out the short-term noise.
In the process, we can then become much better investors.
Disclosure: Royston Yang does not owns any of the shares mentioned.