How many times today have you checked to see how your investment portfolio is performing?
This is an important question to ask because the answer has a lot to do with your investment decision-making and, in turn, your long-term performance. Checking your portfolio balance is not a benign activity; the more you check the more likely you are to invest in lottery-type stocks.
The occasion to discuss this tendency is the recent publication of Berkshire Hathaway’s annual report, which includes the much-anticipated thoughts on investing from CEO Warren Buffett. He famously occupies one extreme of the holding-period spectrum, with a preferred holding period of “forever.”
At the other end of this spectrum are traders whose holding period is a few days. I need not remind you that Buffett has come out way ahead of them over the long term.
The lowdown on cheap stocks
The stocks that Buffett tends to favor are “cheap, safe stocks,” according to a 2018 study in the Financial Analysts Journal. According to the professors who authored that study, Buffett favors stocks with low price-to-book ratios, have exhibited relatively little volatility, and are of companies whose profits are growing at an above-average pace and which pay out a significant portion of their earnings as dividends.
Such stocks’ safety and quality are what allows Buffett to be comfortable holding them for indefinitely long periods. A high-flying stock that is riding a wave of investor exuberance would not qualify, since over the long term such stocks sooner or later are destined to lose in a very big way.
Short-term traders usually find the stocks that Buffett favors far too boring. They’re looking instead for stocks that can pay off in a big way in a very short time. It doesn’t matter to them that such stocks are poor long-term bets.
Commentators have long suspected that smart phones and social media are exacerbating traders’ focus on lottery-type stocks — low-priced stocks with above-average volatility and positive skewness. This latter property refers to the distribution of such stocks’ returns: in contrast to a symmetrical bell-shaped distribution, a lottery-type stock will have most of its values clustered near the left-hand, negative, side but whose opposite, positive, side extends a long way to the right — a long right-hand tail, in statistical parlance. Such stocks often lose money but, when they win, they can win big.
The typical American checks his or her cell phone 344 times per day — an average of every three minutes during waking hours, according to one survey. That’s equivalent to checking 140 times during the trading session on Wall Street. Care to bet whether, during the session, traders on their smartphones are focusing on the cheap and safe stocks that Buffett favors or on lottery-type stocks?
Recent research found the answer. The study, distributed by the National Bureau of Economic Research, is entitled “Smart(phone) Investing? A Within-Investor-Time Analysis of New Technologies and Trading Behavior.” It was conducted by Ankit Kalda and Alessandro Previtero of the Kelley School of Business at Indiana University; Benjamin Loos of the University of New South Wales; and Andreas Hackethal of Goethe University Frankfurt.
To conduct the study, the researchers focused on the trading behavior of clients of two large German banks between 2010 and 2017. It was during this period when the two banks created trading apps enabling clients to trade stocks with their smartphones. The researchers were able to determine whether the banks’ clients were actually executing trades from their smart phones.
The researchers found that, after clients started executing trades from their smart phones, they became 67% more likely to invest in lottery-type stocks.
What happens when brokers send texts to your smartphone?
This evidence is compelling enough. A perhaps even stronger causal connection between smartphones and risk taking comes from another study that appeared last year in the Journal of Financial Economics. Entitled “Attention triggers and investors’ risk taking,” the study was conducted by Marc Arnold of the University of St. Gallen in Switzerland; Matthias Pelster of the Center for Risk Management at Paderborn University in Germany; and Marti Subrahmanyam of NYU’s Stern School of Business.
The researchers studied the trading records of the clients of a large broker that periodically sends messages to clients’ smartphones about individual stocks. The researchers restricted their study to just those messages the broker sent that contained no fundamental news about the company concerned. They nevertheless found that these messages triggered greater risk-taking — 19% more, according to the researchers—by the clients who receive them.
Given that these messages contained no fundamental news, the researchers conclude that the greater risk taking was the direct result of the stocks getting mentioned in the brokers’ messages. The simple fact of focusing on a particular stock —paying attention— led to greater risk-taking.
Focus less frequently on how our portfolios are doing, and turn off text messages and social media feeds about the stock market.
The most obvious investment implication of these studies is that we should focus less frequently on how our portfolios are doing, and turn off text messages and social media feeds about the stock market. But that is unrealistic. Human nature being what it is, telling someone not to pay attention only increases their desire to pay attention.
The next best alternative is to devise a specific action plan for your portfolio that details how you should react come what may — and then to follow that financial plan. That may involve hiring a financial adviser to manage your portfolio according to that plan. If you do these things, then you can pay attention all you want to social media feeds that focus on the stock market.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at firstname.lastname@example.org
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