"At one point, two former employees say, Goldman's top management was demanding hourly profit and loss statements from certain teams [at Goldman Sachs Asset Management].."
- Richard Teitelbaum, Bloomberg News.
The watched pot does not boil. The financial equivalent of this old saw, and one of our personal favourites, which we make no apology for repeating here, is Nassim Nicholas Taleb?s fictional retired dentist. This hypothetical investor is guaranteed to earn 15% per annum from his portfolio with an associated volatility of 10%. These statistics are not open to dispute.
But if our investor friend monitors his portfolio in real time, however, the random price oscillations of his portfolio are likely to trigger extreme anxiety. Depending on the frequency with which he observes his portfolio, our dentist will experience varying degrees of heartache and distress. The frequency of portfolio observation versus probability of a pleasurable shown below:
- 1 second 50.02%
- 1 minute 50.17%
- 1 hour 51.30%
- 1 day 54%
- 1 month 67%
- 1 quarter 77%
- 1 year 93%
(Source: „Fooled by Randomness?, by Nassim Nicholas Taleb
The message is clear. Too much observation can be bad for you. If Taleb?s dentist simply restricts the frequency with which he checks his portfolio – a fundamentally sound portfolio – he will boost his chances of incurring a positive emotional outcome from his monitoring. Note that nothingchanges about the composition of his portfolio – only the frequency with which he checks it. Investors determined to watch the pot may end up being scalded.
There are other reasons to be wary of a focus on the short term. Jim Leitner of Falcon Management once said:
“If all investors allocate money to a one-month time frame, by definition there are going to be fewer opportunities there.. there?s just too much competition over short-term trading, which is a timing-driven business. With timing, sometimes you?re going to be right and sometimes you?re going to be wrong, but it?s not going to be consistent over time.. Meanwhile, the longer-term opportunities still exist because there hasn?t been that much money allocated with multi-year lockups.. That?s not happening yet and probably won?t because investors are way too nervous and shortsighted.”
We draw an additional distinction between the business of trading and the business of investing. Trading, an activity we try and avoid, for reasons of psychological disinclination and cost, is inherently a short-term activity, not unrelated to…
