Michael D. Lam, Senior Editor for Horsesmouth, wrote an interesting article entitled, “A Painful Example of Short-Term Thinking.” In it, he reviews and summarizes a new book, Fooled by Randomness – The Hidden Role of Chance in the Markets and in Life by Nassim Nicholas Taleb.
Lam believes that investors who pore over their portfolios every instant are only hurting themselves. Too much scrutiny causes investors to mistake volatility for returns – or, to use the language of communications theory – to confuse noise with information.
As a hypothetical example of how and why this happens, imagine a retired investor who spends his time tending his nest egg. Assume two things about the performance of his portfolio:
So by definition, over the long-term, the return should average 10%, but there will be years when the return actually dips to 2%. In fact, under extreme conditions (see returns for 2000 and 2001) the return could dip another 8% to -6%. So, even though the long-term return is 10%, the swings from year to year can be considerable.
The problem is, for short-term thinkers, randomness has some unexpected and somewhat shocking results. According to Lam’s article, if the investor looks at his investments every day, he’ll see a loss slightly less than half the time. If he reads only his monthly statements, however, he’ll be pleasantly surprised two-thirds of the time. And, if he calculates his net worth only once a year, he’ll be pleasantly surprised 19 out of 20 times.
If you consider that the pain of loss is more deeply felt than the thrill of equivalent gains (by 2 to 2.5 times), psychologists note our investor’s high frequency review of his accounts would prove painful.
The moral of the story is to stay disciplined. Resist the lure of short-term thinking, which results in an over-investment of time, attention, and analysis in what is at best, strictly meaningless, or at worst, very detrimental to your portfolios.
In difficult times, what message are you sending to your children?
Even though some parents can still afford luxuries, no one wants to send the wrong signals to their children and friends in a struggling economy. Many people are not making ostentatious purchases, such as a high priced luxury vehicle. Instead they are driving their car another year, and not taking the expensive vacation.
What information do you give your children about your finances?
Being a parent is all about walking the fine lines, and there is no finer line than the one between informing and scaring your children.
In these troubling times, sparing your kids the “money talk” is no longer an option.
We do, however, have to watch what we say and how we act. “It is important that you be calm and reassuring,” says Jon Gallo, co-author of The Financially Intelligent Parent.
“Whether you lost your job or half of their college fund, younger kids take what their parents say quite literally. If you say, ‘We don’t have any money,’ or ‘We are going to be broke next week,’ unless it happens to be true, the kids are going to think it is true,” Gallo adds.
Also, listen to your kids. Ask them what they think and what is concerning them. Then, accept their feelings and empathize with them.
Next, ask them to help out. Gallo recommends enlisting your kids as part of the solution. Ask them for ideas on how you might be able to save money. Consider having a regular “family money night.” Instead of feeling deprived, getting the kids involved gives them the feeling they are helping with the solution and that they are participants.
Lastly, try to keep the situation in perspective. “If you are making less money, you are not necessarily losing your home. If you are losing your home, you don’t have cancer. The world is not ending,” says Gallo. “No matter how bad it gets, there are other people in worse shape than you are… try to help them. There are always people out there who need help, and the greatest way to make yourself feel good is to help other people,” he adds.
Gallo strongly recommends the website VolunteerMatch.org, which posts opportunities for hands-on involvement. You can input your zip code and sort opportunities by categories such as children, teens, seniors, or community.
It is a great way to build family unity and help other people.
And, that is a great message to send to your children.