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Data & Research January 8, 2015
Research Supports Use of Auto Investing Solutions
Recent research supports the argument against investors reacting to every market turn and for solutions that automatically rebalance portfolios.
Reported by Rebecca Moore
Research from the Columbia Business School concludes that retirement plan investors may do better to check their portfolios less often and leave investment decisions to others.
Michaela Pagel, assistant professor of finance and economics at Columbia Business School, uses a theoretical model to understand how investors’ behavior depends on how often they check their portfolios. Her model accounts for behavioral research findings that suggest most people have emotional reactions to changes in expectations about consumption, such as when they get news about financial losses and gains, reporting more pain at losing $10 than happiness at gaining $10.
Because the prospect of losing money inflicts so much pain, it bears heavily on how investors perceive risk and make decisions. Applied to a retirement portfolio, that suggests that the happiness of an investor who tracks his portfolio day-to-day will be offset by his unhappiness during down markets; flinching at every market dip, big or small, he’ll be more likely to react in ways that damage his portfolio over the long term, for example, by choosing a very low share in risky assets, which impedes the potential growth of his portfolio.
“If you are always more unhappy when you get bad news than you are happy when you get good news, that implies that, on average, looking up your portfolio is painful,” Pagel says. “Most people, if forced to look at their portfolio every single day, would make a very poor investment decision.”
The model predicts that given the choice, most people prefer to stay inattentive to their portfolios, and this makes them more willing to choose an investment solution that automatically diversifies and rebalances their portfolios or pay for a professional portfolio manager.
Pagel also contends that financial advisers and money managers should understand that they could be doing their clients a disservice by delivering constant updates at every market hiccup. “Portfolio managers should offer to periodically rebalance their clients’ portfolios and advise them on finding an appropriately risky asset share,” Pagel says, “While giving their clients the opportunity to be inattentive.”
The research report, “A News-Utility Theory for Inattention and Delegation in Portfolio Choice,” can be found here.