Archimedes is often quoted as saying, 'Give me a lever long enough and I can move the earth.' In investing, that lever is time. The length of time investments will be held, the period of time over which investment results will be measured and judged, is the single most powerful factor in any investment program. If time is short, the highest investments – the ones an investor naturally most wants to own – will be undesirable, and the wise investor will avoid them.

But, if the time period for investing is abundantly long, the wise investor can commit without great anxiety to investments that appear in the short-run to be very risky. Given enough time, investments that might otherwise seem unattractive may become highly desirable.

Time transforms investments from least attractive to most attractive and vice versa because, while the average expected rate of return is not at all affected by time, the range or distribution of actual return around the expected average is very greatly affected by time.

The longer the time period over which investments are held, the closer the actual returns in a portfolio will come to the expected average.

Risk Aversion

A risk averse investor is an investor who prefers lower returns with known risks rather than higher returns with unknown risks. In other words, among various investments giving the same return with different level of risks, this investor always prefers the alternative with least interest.

A risk averse investor avoids risks. S/he stays away from high-risk investments and prefers investments which provide a sure shot return. Such investors like to invest in government bonds, debentures and index funds.

Loss Aversion

Loss aversion is an important concept associated with prospect theory and is encapsulated in the expression “losses loom larger than gains”. It is thought that the pain of losing is psychologically about twice as powerful as the pleasure of gaining. As people are more willing to take risks to avoid a loss, loss aversion can explain differences in risk-seeking versus aversion. Loss aversion has been used to explain the endowment effect and sunk cost fallacy, and it may also play a role in the status quo bias.

The basic principle of loss aversion can explain why penalty frames are sometimes more effective than reward frames in motivating people and is sometimes applied in behaviour change strategies.

Myopic Loss Aversion

Myopic loss aversion occurs when investors take a view of their investments that is strongly focused on the short term, leading them to react too negatively to recent losses, which may be at the expense of long-term benefits.

This phenomenon is influenced by narrow framing, which is the result of investors considering specific investments (e.g. an individual stock or a trade) without taking into account the bigger picture (e.g. a portfolio as a whole or a sequence of trades over time).

This article was issued by Kristian Camenzuli, investment manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.