3 ways to get better investment results by doing less
The subtle art of doing nothing.
“I am so busy doing nothing…that the idea of doing anything – which as you know, always leads to something – cuts into the nothing and then forces me to have to drop everything.”
- Jerry Seinfeld
I recently wrote an article on the US election. I suggested that in response to the uncertainty investors should do nothing. I also gave a recommendation for a tempura restaurant in Kyoto. If you are ever there you should do something – head to the restaurant.
My recommendation to do nothing was not unique. I made the same suggestion when markets dipped in early August. In fact, I’ve given the same advice in response to almost every instance of uncertainty where outcomes and the ramifications of those outcomes are unknown. To me this is common sense. If you don’t know if something will happen and you don’t know how markets will react it seems foolhardy to act.
This seems like easy advice to follow. It isn’t of course. Doing nothing is one of the hardest parts of investing. I will get into some advice about how to do nothing. But first it is important to understand the data that backs my advice.
I’m going to go through multiple examples. First some background. Many Australians are not very engaged with super according to How Australian Retires a recent study by Vanguard. This may have some surprising benefits.
I do want to clearly state that this group of investors who have never contacted their super fund, can’t recall the last time they looked at their account balance or checked less than once a year are not who you should emulate. I am not advocating a complete head in the sand approach to investing.
The same report finds 61% of Australians don’t have a good idea of how much money they need to achieve the lifestyle they want in retirement, 58% haven’t thought about how old they’ll live, and 67% do not know how long of a retirement to plan for. Perhaps most concerning is the 1 in 2 retirees who don’t know how much money they can spend in retirement. Don’t be like these people.
However, there is something rather unique about Australian investors. Morningstar periodically publishes our Mind the Gap study. It looks at the difference between investor and investment returns. The summary is that all over the world investors manage to earn lower returns than the investments they hold in their portfolio. The difference comes down to poor timing decisions by investors of when they buy and sell certain investments. Doing something detracts from returns.
Below is the result from the survey that looked at six different countries.
Australia clearly did very well. One conclusion from the study is that the compulsory enrolment and the outsourcing of investment management from superannuation funds to funds management companies means that the superannuation system has an inextricable link to aggregate investment and investor returns in Australia.
The same study was done in the US for the same period. The gap was 1.68%. Perhaps Americans are just not very good at investing. However, I don’t think that is the reason. US investors have lots of things that we often perceive as advantages. The world’s largest share market and an overabundance of choice in ETF and fund offerings. Most brokerage in the US is free for both taxable and retirement accounts. There is almost complete autonomy over tax advantaged retirement accounts with individuals deciding how much they put in, what investment options they choose and relatively minor penalties to pull money out at any time.
Some characterise this as freedom. And you do have the freedom to do almost anything you want. You have lots of investment choices, the freedom of action and the absence of any friction to trade. As the saying goes, freedom has a price. That price is the 1.68% gap outlined in our study.
Does the smaller investment / investor gap in Australia mean everything is perfect?
It doesn’t mean things are great in Australia. The apathetic group of people outlined in the Vanguard report may be the ones driving the smaller gap in investment and investor returns in Australia. That doesn’t mean they will achieve any of their goals. Chances are this cohort of unengaged investors has the wrong asset allocation. They likely aren’t saving enough for retirement which I’ve suggested is above the compulsory contribution to super and is at least 15% of salaries. Once again, don’t be like these people.
You should be the foremost expert in you. As Hillel the Elder said, “If not you, then who?”. I’ve always taken this approach with my own finances. I have nothing against financial advisers and think they can play an invaluable role in providing structure to the investment process. I constantly pay people to do things I don’t want to do or don’t know how to do. But I’ve always felt that there is nobody that is more invested in the outcome I achieve than me. And nobody knows more about me than I do. Since I’m interested in learning about personal finance and investing and believe anybody can do it I’ve always just done things on my own.
The lesson is that more Australians need to own their outcomes. The action needed is not to trade more. It isn’t to time the market. It is to understand what you are trying to achieve and what it takes to get there.
What are the other issues with overtrading?
The Mind the Gap data demonstrates the impact to returns from choosing the wrong time to enter and exit investments. The lesson from this data is not to improve your ability to time the market. The lesson is to not try. This is demonstrated by the next round of data.
Professors Odeon and Barber at the University of California performed a famous study of US brokerage accounts. The study looked at times when investors sold one investment to purchase another. The investment sold outperformed the one that was purchased by an average of 3.32% after 504 trading days.
The same professors did a different study which divided investors in quintiles by the amount they traded. Net monthly returns (which include costs) for each quintile were as follows:
- Highest trading quintile = 1.01% per month
- 2nd highest trading quintile = 1.27% per month
- 3rd highest trading quintile = 1.36% per month
- 4th highest trading quintile = 1.41% per month
- Lowest trading quintile = 1.47% per month
A study conducted by UTS explored whether individual investors benefit from the use of ETFs. The study found that portfolio performance when investors used ETFs was lower than when they didn’t.
It wasn’t a small loss. The study found that ETF portfolios underperformed non-ETF portfolios by 2.3% a year. The loss is the result of buying ETFs at the wrong time rather than choosing the wrong ETFs. A critical finding in the study was that ETF portfolios did outperform if the investor bought the investment and held it for the long-term. Is there an inherent problem with ETFs despite the ease with which you can trade them? Of course not. The problem is us.
What you should do about this problem with overtrading
The good news is that we know exactly what the problem is with the way most people invest. The better news is that it is our behaviour that is the issue. It is completely in our control.
That doesn’t mean that this is easy. I remember watching a 60 minutes’ episode about the obesity epidemic in the United States. They were interviewing somebody who dismissively said that this is the only epidemic that could be ended by shutting your mouth and taking a walk. It was a well delivered line. But it ignored the myriad of causes of obesity. Something can be easy in theory and hard in practice.
It is the equivalent of me just telling investors to trade less for better results. It is easier said than done. It goes against our instinctual need to take action when we are confronted by the emotional pull of fear and greed. It goes against the notion that has been pounded into our heads that successful investors are the ones that nimbly navigating each twist and turn in the market. It means resisting the marketing pitches for each new thematic investment product that is perfectly designed to stimulant that little voice in our heads that whispers ‘this will make me rich.’
Just like trying to lose weight it takes multiple strategies to trade less. Below are my suggestions:
Set yourself up with the right foundation to enable structured decision making
I’m not an organized person and this goes against my natural inclinations. I do it because it works. Focusing on a long-term goal pulls me out of the messy present. A defined investment strategy and set investment criteria is a bulwark to a day-to-day existence full of conflicting emotions. My job means I know what is happening in markets far more than is necessary. It means that I’m constantly bombarded with compelling sounding opportunities and dire sounding risks.
Structure removes spontaneity. I want to live a spontaneous life. I don’t want to invest that way. Setting yourself up for success means knowing what you want to achieve and what it takes to achieve it. That means having a goal, knowing your required rate of return and how much you need to save to get there.
Trying to sort through the thousands of investments we can choose from is impossible without having a set of criteria to eliminate a significant portion of this opportunity set. For instance, I won’t buy shares that don’t pay a dividend. I won’t buy a thematic ETF. I won’t buy an actively managed product. After eliminating these broad categories I have a set of criteria for what I will buy. All of this is written out in my investment strategy.
I do this knowing that there will be many investments that will have great performance that are in the categories I avoid. But I know the biggest risk to achieving my goals is my own behaviour. And I know that always trying to be in the best performing investments means I will constantly churn my portfolio.
Find an investing mate
Dance like nobody is watching. Invest like everyone is watching. We tend to find ways to justify things we want to do. We tell ourselves we can have one more cookie and work out extra hard tomorrow. We reason our way into one more martini because we didn’t have a drink on a random Tuesday three years ago. Sometimes all you need to resist these urges is to have somebody to hold you accountable.
Pick a mate and share your goals and investment strategy with them. When you want to make a change to your portfolio outline your rationale to your mate. Include both why you want to make this change and what could go wrong. Just this process of documenting your thinking might stop you from doing anything.
Preparing to rationalise your decision making to another person will make your more thoughtful. Explaining it to a mate adds a further step to the trading process. This human interaction is something we’ve lost with the anonymity and ease of online trading. Perhaps most importantly these steps will slow your decision making. It will let the underlying emotions that may be driving your desire to trade subside.
Have a default routine of doing nothing
There is a long list of reasons why healthy routines are beneficial. A routine is how we build habits. They lower the impact of stress. They help to reframe our thinking in positive ways.
A routine does not mean you never vary from it. I am not calling for investors to never do anything. However, a routine of doing nothing in response to market events raises the bar on taking action. This is helpful when so many of these events are blown out of proportion and portrayed as unprecedented when that is far from the case.
If you want different results you need to do something different from most people. Most people switch investments too frequently. To be a true contrarian all you need to do is less.
Give these approaches a try. And also let me know anything you’ve added to your investing approach to resist the temptation to chase performance and react to each event and gyration of the market at [email protected]
