Don't just do something, stand there!

We're a can-do people.  From a young age, we're taught that effort leads to results.  But, when it comes to investing, activity is not the same as effort.  In other words, it is frequently better--as an investor--to stand there instead of doing something.

This is tough for can-do people to swallow.  They want to trade and switch and act to achieve success.  This may work well in many fields, but investing is not one of them.  This is as true for professional as non-professional investors.

This point is well made in Michael Mauboussin's latest article, "The Coffee Can Approach."

Mauboussin's article refers to a professional investor's experience with a client.  The client had copied some of the professional's initial investment choices in their own separate portfolio and then just forgotten about it for years.  Over time, the forgotten portfolio had greatly out-performed the professional's own record.  Some investments had done poorly, but others had done so well it was best to leave them alone.  Instead of doing something, the professional investor--and his clients--would have been better off doing nothing after the initial allocation.

The difficulty is that this method takes great patience and many years to work out.  If you examine your portfolio too frequently, you'll make changes that tend to yield sub-optimal results.  Just as a watched pot doesn't boil, an over-examined portfolio doesn't grow.

This framework is born out by research from the investment field.

John Bogle found that exchange-trade fund (ETF) investors were on average under-performing the reported returns of the ETFs they invested in--by a whopping 4.5% a year!  Why?  Investors were buying things that had gone up and selling things that had gone down.  They would have gotten significantly better returns if they had patiently stayed where they were.

Professional investors don't do much better.  Institutional plan sponsors--usually investment committees of professionals--consistently fire managers that have recently done poorly and hire managers that have recently done well.  The result: the fired managers subsequently out-perform the hired managers by a wide margin.  Plan participants would have been significantly better off if plan sponsors had left things alone.

People, both professionals and non-professionals, tend to evaluate investment managers over three year periods.  And yet, research indicates that you need a period of a decade or more to confidently conclude a manager has skill.

In fact, some research suggests that only 35% of skilled managers show up in the top 10% over 1 year periods, and only 50% of skilled managers show up in the top 10%--even with a 10 year evaluation period!

When it comes to investing, picking good investments or good managers should focus much more on the initial decision, and then being patient with that choice over time.  Without a doubt, this is hard for can-do people to embrace.

The evidence, however, is clear: recent out-performance is no guarantee of future out-performance, and recent under-performance is no proof of poor future performance.  With investing--once an good initial decision is made--it's better to stand there than do something.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.