NEW YORK—Fresh off of the New Year, this is a prime time for routine investors to review their portfolios and decide whether it’s the right time to rebalance them. Others might have already rebalanced their portfolios several times to account for each recent stock market rise and fall. But, which approach yields the best results for your retirement savings? Research from Columbia Business School finds that investment portfolio growth can actually suffer from too much attention.
Michaela Pagel, assistant professor of finance and economics at Columbia Business School and an expert in “household financial decision making,” shows that when people do check their holdings frequently, and attempt to rebalance on their own, they make investment decisions they believe will decrease pain and increase happiness—which often leave them worse off financially over time.
Her suggestion? Simply check your portfolio less often.
“History has shown us that the stock market is a relatively safe bet over the long term because it has typically grown,” said Professor Pagel. “Investors would be wise to keep this in mind, because those that check their portfolio too often and are driven by the daily or hourly fluctuations in the market may make decisions that have a negative impact on their long-term financial prospects.”
The research, titled “A News-Utility Theory for Inattention and Delegation in Portfolio Choice” creates a new theoretical model to evaluate how the frequency of portfolio interaction affects investors’ behavior. The model shows that because the prospect of losing money is painful, it bears heavily on how investors perceive risk and make portfolio-rebalancing decisions.
Pagel’s model is an innovation on the standard economic model of investor behavior, which focuses on investors’ consumption only in the present. Her model also accounts for other research findings that suggest most people have emotional reactions to changes in expectations about consumption.
There has been a rapid increase in the fraction of US households owning equities, from 33 percent in 1989 to 51 percent in 2007. Much of this has been due to the dramatic growth in individually-managed, defined-contribution retirement plans, where people choose how much of their retirement funds are allocated across various assets. This trend suggests that the quality of investment decisions made by individuals will be increasingly important to future living standards.
As policymakers in the US and elsewhere consider adding an individual-account component to Social Security, a key issue will be whether people will make suitable investment decisions. Poor choices could potentially leave people with significantly lower retirement spending options.
One note of caution: this research does not imply that you should just simply forget about your retirement portfolios or leave them to chance. Your ability to make sound financial decisions is still extremely important to growing your retirement savings. And, when it comes to your financial advisor, they should realize that delivering updates too frequently or rebalancing portfolios at every market hiccup is actually to their clients’ detriment. Instead, these advisors should offer to periodically rebalance their clients’ portfolios and advise them on finding an appropriate asset allocation based on their tolerance for risk, while giving their clients the opportunity to relax their minds and not pay too much attention to every twist and turn of the market.
To learn more about the cutting-edge research being conducted at Columbia Business School, please visit www.gsb.columbia.edu.
About Columbia Business School
Columbia Business School is the only world-class, Ivy League business school that delivers a learning experience where academic excellence meets with real-time exposure to the pulse of global business. Led by Dean Glenn Hubbard, the School’s transformative curriculum bridges academic theory with unparalleled exposure to real-world business practice, equipping students with an entrepreneurial mindset that allows them to recognize, capture, and create opportunity in any business environment. The thought leadership of the School’s faculty and staff, combined with the accomplishments of its distinguished alumni and position in the center of global business, means that the School’s efforts have an immediate, measurable impact on the forces shaping business every day. To learn more about Columbia Business School’s position at the very center of business, please visit www.gsb.columbia.edu.