Myopia is a common condition for many people. If left untreated, this condition can be dangerous for the sufferer and others. Would you want to share the road with a myopic driver who isn’t wearing corrective lenses? Fortunately for those of us who have this condition, corrective lenses or laser surgery can remedy it. Myopic thinking, on the other hand, is common in humans and much more difficult to “cure”.
Myopic or short-term thinking shows up in many ways. Those slices of pizza or cookies can sabotage the best intentions of a dieter. That trip, car, or house that we can’t afford, but buy anyway, are examples of myopic thinking that sabotage long-term plans for financial security.
Myopic thinking is often costly to investors. Why? Most investors chase recent (think one year or less) returns in hopes of replicating that short-term success. They are prone to feeling positive about last year’s hot assets (as those returns are touted endlessly in the media) and project that past performance into the future. An example of short-term investment thinking is comparing the 2014 returns of large-company U.S. stocks (the Standard & Poors 500) to a globally diversified stock portfolio.
Investors who invested only in the S&P 500 last year, with or without bonds in the portfolio, outperformed globally diversified stock portfolios by a wide margin. The S&P 500 returned 13.7% vs. 2.3% for the global stock portfolio in 2014. The myopic investor asks, why would I own that crummy global portfolio when I could own the S&P 500 and make a lot more money (they also confuse past tense and future tense)?
The answer to this question is to look at longer-term results. For the period from January 1, 1970 through December 31, 2014, the performance of a global equity portfolio was significantly higher than the performance of the S&P 500. Perhaps the clearest example of this the growth of $10,000 invested in each of the portfolios. A hypothetical $10,000 invested in the S&P 500 for that 45-year period grew to $884,500. Not bad until you compare that to a hypothetical $10,000 invested in a globally diversified stock portfolio that grew to $2,299,300! Which would you rather have, $884,500 or $2,299,300?
It's important to note that that extra return came at the price of more volatility (risk). If the risk of a 100% global equity portfolio is too much, a less volatile portfolio comprising of 60% globally diversified stocks and 40% U.S. bonds grew to $1,016,600. In this case, global diversification added $132,100 with less than two-thirds less risk (as measured by "standard deviation" - a measure of volatility).
Investors who overcome myopia and took a long-term view, acted on the evidence, and created a well-diversified portfolio saw their efforts and patience richly rewarded.
Data Source: Dimensional Funds (click here for complete data sources and descriptions)