Thursday, May 07, 2015

the unvirtuous cycle of impatience

In a fantastic speech in 2010, Andy Haldane, Executive Director, Financial Stability at the Bank of England wrote:

If preferences evolve over time, this gives rise to the possibility of self-reinforcing patterns of behaviour. Such evolutionary trends have been extensively studied by sociologists, psychologists and even some economists. These studies confirm the old aphorism: virtue is its own reward. Specifically, patience is capable of setting in train a cycle of self-improving behaviour in individuals, economic and social systems. Take happiness. Studies have shown that happy people save more and spend less. Happy people also take longer to make decisions and expect a longer life. In short, they are patient. These patterns of behaviour are connected and reinforcing. Expecting a longer life, happy people defer immediate gratification and save. In consequence, they enjoy a more prosperous tomorrow as they harvest the fruits of their investment. In these models, happiness is not just fulfilling; it is self-fulfilling”.

The Unvirtuous Cycle
Unfortunately the majority of Wall Street marketing, incentives, and models are based on an unvirtuous cycle of impatience – rapid trading, 24 hour news coverage, instant transactional capabilities, etc. As investors participate to a greater extent in this system, the more reinforced these habits become. In essence, Wall Street is incentivized for impatience while investors are penalized.

We can see a clear demonstration of this impatience in the average equity holding period since 1950. At that time the average was roughly 6.5 years. By 1990 this had dropped to less than 2 years (1 year 10 months). By 2000 it was 11 months and by 2010 was 6.8 months. In technology stocks this bottomed in 2000-2001 with an average of less than 30 days for nearly 50% of the Nasdaq 100. Clearly that is not patience.

Another way to look at this problem is the change in investor returns. In 1990 we estimate that investors in US equity funds captured roughly 95% of total returns. Put another way investor decisions and fees cost them roughly 5% of their return. By 2010 – with turnover at an all time high – investors were capturing roughly 88% of market returns. Impatience costs you money.

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