How often should one check the portfolio?
Professors Richard Thaler and Shlomo Benartzi came up with a very interesting study of human behavior. They studied how investors behave when they evaluated portfolio performance more often. They came to a conclusion that “the more frequently people evaluated their investment performance, the lower the returns they could expect to achieve”. This was presumably for one of two reasons:
- When seeing poor portfolio performance over short term, they would experience pain. This pain would drive them to make short-term counter-productive investment decisions. Or
- They would settle for a more conservative portfolio, which comes with lower anticipated returns.
The result would be poor long term performance of one’s investments.
This reminded of a very old story. There was a man who had a garden in his backyard. There were small plants with beautiful flowers. There were flowers of various colors growing in different seasons. He nurtured it very well. He was proud of his garden. He had a young son, who observed what his father did every day, but did not understand anything.
One day this man had to go out of town for a couple of weeks. He was worried about his garden. He called his son and gave him instructions to water the plants. The son, who was always curious to know what his father did in the garden, asked his father what will happen if he watered the plants. The father explained in detail what he had been doing – planted the seeds, put fertilizer in the soil and then regularly watered the plants and removed the weeds. He told his son that now he had to only water the plants. This will help the seeds to take roots and the roots will get grip in the soil. Then the plant will grow and then have beautiful flowers. The son readily agreed to help. He found the job to be very easy.
After two weeks the man returned home. After taking some rest, he went to see the garden. He got very angry when he saw that all the plants were dead. He called his son and scolded him. The son did not understand why his father was so angry. The man asked his son to explain what he did. The son said he did exactly what the father had asked him to do. However, when he kept checking the plants did not take any roots. Every day, he took out each plant from the soil to check.
The father understood what the son had done.
If we keep checking the investments the way the son did in the story, imagine what will happen to our garden – our portfolio.
It was easy for the father to pardon his son given the young age. But when we do this to our investments regularly, there is nobody who will pardon us.
Thaler and Benartzi termed this the "psychological cost" of frequent evaluation.