What do your inbox and your retirement portfolio have in common? You should probably check both less frequently. Just as productivity can suffer from constant e-mail monitoring, investment portfolio growth can suffer from too much attention, according to new research from Professor Michaela Pagel.
Pagel, whose research focuses on household financial decision making, uses a theoretical model to understand how investors’ behavior depends on how often they check their portfolios. Her model is an innovation on the standard economic model of investor behavior, which focuses on investors’ consumption only in the present; her model also accounts for other research findings that suggest that most people have emotional reactions to changes in expectations about consumption, such as when they get news about financial losses and gains, reporting more pain at losing $10 than happiness at gaining $10.
Because the prospect of losing money inflicts so much pain, it bears heavily on how investors perceive risk and make decisions, Pagel’s model shows. “Viewed over a long horizon, the stock market appears relatively safe, because historically it has typically gone up,” she explains. “There’s a pretty good chance the market will go down on any given day or week, but the probability of loss is much lower when you look over a long-run period such as two decades.”
Applied to a retirement portfolio, that suggests that the happiness of an investor who tracks his portfolio day-to-day will be offset by his unhappiness during down markets; flinching at every market dip, big or small, he’ll be more likely to react in ways that damage his portfolio over the long term, for example, by choosing a very low share in risky assets, which impedes the potential growth of his portfolio.
“If you are always more unhappy when you get bad news than you are happy when you get good news, that implies that, on average, looking up your portfolio is painful,” Pagel says. “Most people, if forced to look at their portfolio every single day, would make a very poor investment decision — they would find it so painful that they would not invest anything.” The solution? Check less often. (One recent industry study found that the best-performing portfolios were those that had been utterly forgotten.)
Overall, her model shows that when people do check their holdings frequently and attempt to rebalance on their own, they make investment decisions they believe will decrease pain and increase happiness — but often leave them worse off over time. It also predicts that given the choice, most investors would rather avoid checking their portfolios, and that this makes investors more willing to pay a professional portfolio manager, who, at a greater emotional distance from the ups and downs of any individual investors’ portfolio, actively rebalances their portfolio on their behalf.
That doesn’t mean shrugging off responsible financial decision making. But financial advisors and money managers should understand that they could be doing their clients a disservice by delivering constant updates at every market hiccup. “Portfolio managers should offer to periodically rebalance their clients’ portfolios and advise them on finding an appropriately risky asset share,” Pagel says, “While giving their clients the opportunity to be inattentive.”
Michaela Pagel is assistant professor of finance and economics at Columbia Business School.
Michaela Pagel is an Assistant Professor at Columbia Business School. She received her Ph.D. from the Economics Department at UC Berkeley and works on topics in household finance. Her current work focuses on the consumption and investment implications of non-standard preferences. More specifically, she analyzes how decision-making is affected by people's beliefs about their consumption. She tests the implications of these preferences...
Read the Research
"A News-Utility Theory for Inattention and Delegation in Portfolio Choice"