The best retirement financial advice you can get might be to get more sleep.
That is the provocative implication of recent research that examined investors' financial risk-taking following periods when their sleep was disrupted.
I concede that advice to get more sleep is hardly new, since we've been hearing that most of our lives — and the advice is honored more in the breach than in the observance. Furthermore, retirees typically would like to sleep more, but can't — due to the disruptions in sleep patterns that are a normal part of the aging process. But that doesn't change what this new research shows: Sleep disruptions can have very serious, real-world consequences for your portfolio.
The study in question, "DEEP Sleep: The Impact of Sleep on Financial Risk Taking," was conducted by John Nofsinger, a professor of finance at the University of Alaska Anchorage, and Corey Shank, an assistant professor of finance at Georgia's Dalton State College. The professors gave a battery of tests to 126 upper-level students in economics and finance who, since they were well versed in the concepts of risk and reward, presumably were less susceptible than the average investor to be irrational when it comes to assessing risk. The researchers carefully tracked participants' sleep patterns according to a number of standard measures, and then had each of them take a battery of tests to reveal their attitudes toward risk.
The researchers' overall finding was that, when deprived of sleep or otherwise suffering from sleep disruptions, we tend to incur more risk than we typically do when we have had more sleep.
One series of questions focused on perceptions of probability, which are distorted by sleep disruptions. One such distortion emerged when participants were asked to distinguish between an increase in probability from 5% to 10% and another from 90% to 95%. When sleep became disrupted, the researchers found, participants were more likely to think the former increase is greater than the latter. (In fact, of course, both represent the same extent of an increase.)
One consequence of this probability distortion, Nofsinger told me in an interview, is that it leads participants into having a greater likelihood of buying options. As we already know, of course, the vast majority of all options trades are losses.
Another risky behavior that the researchers found to be associated with poorer or less sleep is under-diversification. Those with sleep disruptions tended to have less diversified portfolios than those who got more and better sleep. Under-diversified portfolios, of course, are more volatile than they need to be in order to deliver a market-like level of return — if even it performs that well.
In addition to pointing out why we should get better and more sleep, this new study also suggests that we be on our guard for those periods in which our sleep, for whatever reason, has become disrupted (hopefully temporarily). As Nofsinger put it, "Since we some control over when we take on risky behaviors, we can time them from times of the day, or days of the week, when we have the most sleep."
Though this study is the first that I know of that specifically correlated sleep disruptions with risky investment behavior, there have been others over the years that were at least suggestive of such a connection. One worth drawing your attention to is titled "Losing Sleep at the Market: The Daylight-Savings Anomaly," which was conducted by Mark Kamstra of York University; Lisa Kramer of the University of Toronto, and Maurice Levi of the University of British Columbia.
In that study, the researchers found that the stock market's returns are significantly below normal, on average, on the Mondays following shifts to daylight-saving time. In speculating about why this might be, the authors pointed out that "We have all struggled through a day after a poor night's sleep, weighed down by weariness, fighting lethargy, and perhaps even facing despondency."
The bottom line: Get more sleep! And if by chance you don't, know your limitations — and don't engage in any risky financial behavior on such days.