Hyperbolic discounting – a possible explanation for the decline in stock holding periods

Let’s face it, as a species we are pretty bad at planning for future events. The bias for disproportionately overvaluing rewards today has a technical name – Hyperbolic discounting. So as a reward goes further into the future, it is assigned lesser value, however the appeal drops off exponentially, not linearly with time. This is because as an event is pushed away into the future, we tend to think of it as a fuzzy, faraway point in time rather than a fixed time frame.

The effect of this on investing has been that as information flow and the convenience of trading in the stock market has increased, holding periods have dropped off significantly since a peak around the 1940s.

Holding periods

The impact of this on investments today are –

(1) People would rather sell for a quick profit rather than let a company compound over 10,20,30 years. I bet people who did this with quality compounding machines – businesses like ITC, Nestle or Asian Paints a decade or two ago must be feeling rather silly

(2) Neglecting dividend yields today because they feel small. Over time, the dividends received should be seen as a sort of “cash back” not only reducing your acquisition cost, but giving you disproportionate yields on your original investment. It helps to think of it as holding an equity-bond, which pays you interest in the form of dividend as it moves up towards its intrinsic value (which the truly great companies keeps increasing over time)

(3) Short term news events and macroeconomics are given disproportionate weight-age, with recency bias (over-weighting the impact of recent events) and focusing effect (relying too heavily on the first piece of information offered when making decisions). Study history and you will see that all of this has happened before, and all of it will happen again. News anchors will have you believe from time to time that the sky is falling with headlines like – “Sensex plunges 500 points!”. Ignoring their fear-mongering is better for your financial and mental state.

On a related note, I find the notion of profit booking and stop losses to be asinine for someone who wants to benefit from company growth rather than the investor perception. Companies do not change or grow significantly over days or months. As Warren Buffet once said, “you can’t make a baby in 1 month by getting 9 women pregnant”.

The moral of the story is to avoid the mistake of killing the golden goose and making roast out of it after it lays its first egg. Aspire to be as patient as this man – Janak Mathurdas, whose family has held shares for generations. If you haven’t seen his interview – its worth a watch. No pretensions, just a simple, clear philosophy and a love for investing.

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