Noise vs. Meaning: The Key to Investment Happiness

investment strategy

cutting trough the short-run noise often helps provide longer-term meaning

By

Paul Ashworth, Managing Partner
David Clark, Director
Antony James, Analyst


Posted 24 May 19

Is the recent collapse in the share price of Company ABC a buying opportunity (noise), or symptomatic of underlying change in the company’s prospects (meaning)?

The key to investment happiness

The answer is not always apparent, especially over shorter time frames. However, by adopting a long-term perspective, investors can maximise the information ratio of longer-term meaning to short-run noise.

Over short periods, stock price movements are more or less random. Over a very narrow time increment, an observation will reveal close to nothing. This phenomenon is neatly illustrated with a simple Monte Carlo simulation (table 1), that estimates the probability of a positive return for a basket of securities over different time scales. Over any one minute of time, there is a 50.17% probability of success – and conversely a 49.83% chance of failure.

Monte Carlo simulation

Diagram showing Monte Carlo simulation

To put this another way, let us consider a diligent investor that checks their portfolio balance every minute over the course of a trading day (eight hours). This investor would experience 241 successful minutes, 239 unsuccessful minutes and will have little appreciation for the underlying meaning in portfolio performance. As we feel greater pain from a loss than pleasure from gains, our diligent investor finishes each day less happy than they started.

In contrast, an investor that checks their portfolio balance once a year would on average experience 19 successful years for every one unsuccessful year. They have achieved the same total return as our diligent investor, but by removing the short-term noise and focusing on the long-term meaning, they also achieve investment happiness.

Avoiding Myopic Risk Aversion Through Asset Allocation

Individuals who receive investment performance too frequently can become susceptible to a behavioural phenomenon called myopic risk aversion. These individuals tend to underinvest in riskier assets; losing out on the potential for better long-term gains.

Our approach to asset allocation strategy frames risk tolerance through a measure of the expected number of negative returns in 20 years. By taking a longer perspective of investment goals, we can separate noise from meaning and focus on your optimal long-term asset allocation.

Your Strategic Asset Allocation will set the frame for your risk tolerance, matching your long-term asset class exposures to your investment objectives, and avoiding behavioural pitfalls. Over the investment cycle, the optimal combination of asset classes will vary as economic conditions change. To take advantage of these mis-pricings in markets, we utilise Tactical Asset Allocation to make modification shifts to your allocation.

Cameron Harrison’s Investment Team addresses the interplay between Strategic and Tactical Asset Allocations by our:

  • Investment Managers monitoring the health of your portfolio continuously and adjusting based on our latest research,
  • Investment Committee meeting monthly to discuss and review asset class strategy, and
  • Investment Board meets semi-annually to undertake a deep-dive assessment and dynamically adjusting asset allocations.

Dynamic Asset Allocation

Diagram showing Dynamic Asset Allocation

Peace of Mind Investing

Cameron Harrison have been advising business owners and their families on asset allocation and intergenerational wealth management for over 50 years. We have demonstrated our ability to manage investments through both the good times and bad by keeping the client at the centre of our business.  For more information on our approach to investment management or any other inquiries, please contact us on +613 9655 5000.