People are sometimes surprised to learn that in the world of investments it often pays to do nothing.
Of course, choosing to do nothing due to laziness is not a good investment strategy. On the other hand, choosing to do nothing in a considered way is a relatively good investment strategy. For most investors, seeing through periods of market volatility and simply allowing investment returns to compound is by far the best strategy over time.
When the global financial crisis hit in mid 2007, the uncertainty and speculation that followed had an adverse impact on investor sentiment. We know that sharemarkets are driven largely by investor sentiment in times of uncertainty, so it was not surprising that sharemarkets around the world were volatile. But “volatile” is not the same thing as “risky”. Along the way, it seemed that the world was about to end. Fortunately, the world doesn’t end very often, and by early 2009 sharemarkets began to recover because investor sentiment turned.
Over the past 40 years, behavioural finance experts studying how investors make decisions have gained deep insights into the psychological elements that affect decision making. One of the most wealth-destructive behaviours that all investors, even professional investors, suffer from is an “action” bias. When sharemarkets are volatile, investors feel compelled to do something, to take some sort of action, even if it’s in their best interest to do nothing. To overcome action bias, investors need to be aware of it, change their behaviour when they recognise it and do nothing.
Of course, we all make mistakes, usually due to poor choices. One of the most admirable attributes of successful people is that they learn from their own mistakes, and they learn from the success and wisdom of others, so that they can make better choices in the future. Successful investors know that they cannot consistently buy at the bottom of the sharemarket or sell at the top of the sharemarket. To win the sharemarket timing game requires investors to take action at just the right time, to be there when “lightning strikes”. Trying to time entry into and exit from the sharemarket is a loser’s game because it can rarely be done. Sadly, most investors that choose to play the sharemarket timing game eventually make bad choices and hand back all of their gains (and perhaps more) to the sharemarket. For most investors, the end outcome is vastly better if they choose to do nothing during periods of market volatility and simply allow the passage of time to compound investment returns.
For instance, in the early days of the global financial crisis, some investors found it relatively easy to decide to move their money out of market-linked investments (which are often well-diversified exposures across asset classes) into cash investments (typically a single undiversified asset class). However, in making that choice, investors implicitly committed to having to make another choice further down the track – when to move out of cash and back into markets. Investors who took this course of action most likely missed out on the returns from sharemarkets – you had to be out of cash when the share markets turned in March 2009.
Unfortunately, when share markets are volatile, investors’ action bias beckons them to play the losers’ market timing game. Most of the time, successful investors are able to resist the temptation to take action when share markets are volatile – they choose to simply do nothing.
Sam Sicilia is the chief investment officer of Hostplus