Volatility

I read in one of my investment books that people are naturally risk-averse. People prefer the predictable to the volatile. In the study I read about, people were shown two charts with bar graphs of daily gains/losses on theoretical investments. A horizontal line in the middle ran across the graph indicating zero. Bars above that line indicated gains and bars below that line indicated losses.

The first graph (not the one posted here) showed short but relatively similar sized bars that all sat on top of the zero line, meaning small but regular gains much like what you would expect from instruments such as treasury bills. The second graph showed longer bars but scattered above and below the zero line. Much like the red bar graph I have in the image I posted here.

The participants in the study were asked to choose from the two charts which they preferred assuming they represented real money investments for them. Most chose the first graph. Very few found appeal in seeing losses on their investments. However, when the corresponding line graphs of investment values for both theoretical investments were shown, they quickly changed their minds when they realized that the second choice actually gave them much bigger gains in spite of the intermittent losses.

The second graph shown in the study looks almost like my actual daily chart posted here (the red bar chart at the bottom). If you study how my portfolio behaves by just looking at that bar graph, you’d probably squirm at the notion of losing 3 or 5 thousand pesos on many days. Looking at the line graph on top though shows you that the value of the portfolio is actually increasing albeit not in a straight line.

I believe this is what plagues many investors – shortsightedness. They cannot see the bigger picture. Investing should be viewed on longer time horizons. Investors who squirm at losing a few thousand pesos in one day usually get rattled and end up selling their positions, not realizing that doing so makes them lose the gains that they would have enjoyed in the longer run had they stayed put. I’ve started tracking my portfolio’s daily closing values and graphed them for some time now. It has helped me a lot. Losing thousands of pesos a day doesn’t rattle me as much anymore because I see the big picture. You should do this too.