It seems like an unquestioned maxim of investing: "keep a close eye on your investments". The question is, how close is enough, and is it possible to be too focused on the daily vicissitudes of the stock market and fall prey to a series of mental and emotional foibles?
I have clients who tell me that they check their accounts daily to see how it is doing. Other clients, rarely if ever go online to check daily performance. Instead, they rely on periodic statements sent from the custodian to show them how they did for a certain period (e.g. one quarter). Others, rely on a periodic discussion with their advisor to discern how they are doing. So, who's right?
Well, the answer, it appears, can be found in the science of statistics and behavioral psychology. Statistically speaking, checking a portfolio daily for performance information is very likely to result in a distorted view of actual performance if we use the normal bell-shaped distribution of returns, which almost all investment analysis depends on. If you had a portfolio that had a 15% expected rate of return and 10% volatility (or "standard deviation") then you would have a 93% probability having a positive result in any given year. Now what happens if you check that same portfolio on a quarterly basis? Now the probability of seeing a positive return drops to just 77%. If you check your portfolio monthly, the probability of seeing a positive return drops further to 67%. If you check your portfolio every day, you would see a positive result from your portfolio just over half the time, 54%! In other words, time scale matters when looking at investment returns and the likelihood of getting a false impression of your portfolio's performance goes up dramatically (the difference between 54% and 93%) the more frequently you check (N. Taleb, "Fooled By Randomness", 2004).
Now consider the impact of those distortions on one's psyche. We see how statistically speaking, we are receiving a lot of "noise" when we focus on short term investment results compared to annual comparisons. Although that noise has an objective bias, it also results in a profoundly emotional reaction within us. A highly regarded study by researchers Amos Tversky and Nobel Prize winning Economist and Psychologist Daniel Kahneman showed that we experience the pain of loss twice as much as the joy from our gains. They termed this phenomenon "loss aversion" and in practical terms it translates to: investors hate losing twice as much as they enjoy their gains (Prospect Theory: An Analysis of Decision Under Risk , A. Tversky, D. Kahneman, 1979). So, not only are we likely to become misinformed by excessive performance checking, we are also likely to induce in ourselves a highly negative and stressful emotional state, based almost entirely on statistical noise!
The answer, it would seem, is to first recognize this situation as a trap that all of us are subject to (except for that mythical 100% rational person) and then temper our curiosity with the knowledge that results may not be what they seem - especially over short time frames. Ultimately, making smart and healthy financial decisions means understanding how our emotional selves can get the better of us and our judgements, if we let it.