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Short-Sighted Risk Aversion

  • Willard Lloyd
  • October 31, 2019
Reading Time: 4 minutes

Would you take this deal? I’m going to flip a coin. If it comes up heads, you win $200.00. If it comes up tails, you lose $100.00.

Most would decide not to play. It’s just not worth it. The odds are not in your favour. It’s nice to win $200.00 but nobody wants to lose $100.00.

This mindset applies to clients who fret over their account balances daily. In a bad market, the odds appear to be heavily stacked against us. It’s just not worth taking the risk when every day brings bad news when the odds are not in our favour.

What if you offered to flip the coin one hundred times? That would give somebody pause. The odds appear better. They may not be, but the long game is more appealing. It seems we have a better chance of winning over time.

What’s the lesson here? The lesson is that the longer our time horizon, the less threatening we find negative short-term performance. Our comfort level is high. Conversely, the shorter our time frame, the less willing we are to take risk. All clients are risk-averse, no matter the time frame. But they are risk-averse over the short term. This constant checking of prices and the subsequent aversion to negative performance is called myopic (short-sighted) risk aversion.

We all suffer from loss aversion. We’d rather not lose money, thank you very much. But loss aversion and myopic loss aversion are not the same things. Myopic loss aversion causes one to lose sight of the big picture, to focus solely on short-term losses. It is a far better focus when we realize that every long-term strategy will have occasional periods of loss.

The definition of myopic risk aversion as “The combination of a greater sensitivity to losses than to gains and a tendency to evaluate outcomes frequently.” In plain English, the more often we check our investments, the less risk we are willing to take. The longer the game, the more risk we will take. You know from your own experience that those clients who check prices daily take fewer risks and make less money.

In our first example, you would look at the tossing of a coin once to be incredibly risky. The possible willingness to flip the coin one hundred times comes about because you look at one hundred flips as one game, not one hundred individual flips. The game is longer so the chance of success appears greater.

Myopic risk aversion is obsessing on short term market performance and failing to see that short-term performance is an occasional part of a longer game. It is having a well-diversified portfolio that’s performing well and focusing on that one investment that’s underperforming.

You better get familiar with the phrase because you’re about to become an expert in it.

We are overdue for a bear market. It may come next week or it may not come for five more years. But it’s coming. Obsessing on short-term losses will cause inaction. We will guide your emotions, to show you that The average bear market lasts ten months. The average time between bear markets is typically about four years. Those are good odds.

the discussion around the Kofkin Bond portfolios has showcased a service that we believe to be in comparison to a 5star hotel, a 4-star hotel meets the needs of the customers quickly and efficiently. A five-star anticipate the needs of the customer. Showing the support of our clients within a bad market, we have seen this movie before and we understand that it may look grim but a happy ending will conclude. the reminder to our clients when the market is performing poorly the data will look bad, but the data is notoriously short term. If you look at short term data in a down market, the majority if not all, of the performance will be negative. Do not allow a short-term reaction to having a lifetime negative impact. That’s the single flip of a coin. Short term performance is volatile. Volatility flattens out over time.

What would you decide if we offered you this deal? Put your life savings in the stock market. But the deal is only for one year. The year may be good or it may be bad. Who knows? At the end of one year, you have what you have for the rest of your life. You may double the size of your portfolio of you may lose half. Only a crazy person would take that deal.

Here’s another deal. Put your life savings in the stock market and leave it there for the rest of your life, knowing there will be occasional bad years. After all those years, you have what you have. Anybody would take that deal. The chance of loss would most likely be zero.

The proper focus is to look at one’s portfolio as a whole over a long period. If we obsess over the short-term or if we look at the one sector of our portfolio that is underperforming, we lose sight of the long game.

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