It's Okay to Do Nothing
Don’t do something. Stand there!
Markets this year have people swinging between euphoria and depression — although it is likely many more are feeling sad rather than happy at the present moment. These swings likely have investors itching to change their investments in response to what had happened, or perhaps they’ve already done so. It is natural instinct.
Michael Mauboussin is a finance professor at Columbia, he currently heads the research team at a Morgan Stanley investment division. He noted in an interview that the 'work ethic’ is something we have all been taught from young, i.e. that hard work equates to better outcomes. On that note, it is expected that in light of the turbulence in markets, there arises a feeling that something needs to be done. However, this does not necessarily ring true most of the time for investing.
Fidelity investments studied the performance of their client accounts sometime back in 2014. Funnily enough, they found that the best performing accounts were from the clients who had forgotten that they had accounts, or clients that were quite literally dead. This meant that the best performing accounts were owned by clients who did not intervene when markets were going up or going down — they didn’t shift to cash when stocks were falling, neither did they chase bubbles when prices were soaring. They simply did nothing.
An academic study published in 2009 looked at the losses suffered by individual investors from trading; one of the findings was that individual investor trading resulted in systematic and economically large losses. The performance of those investors were aggregated and it showed that they underperformed the market by -3.8%. The study noted that virtually all the individual trading losses were traced to aggressive orders.
A survey into investor behaviour during the most recent turbulence (the COVID-19 crisis) showed that nearly 50% investors shifted their assets to safer instruments or cashed out in fear.
So, did those shifts make sense?
Investment giant Vanguard reviewed all of their client accounts and the actions those investors took during the COVID-19 pandemic. In a study titled Cash panickers: Coronavirus market volatility. The diagram below shows what happened.
In the left panel, in the early part of the COVID-19 sell-off, the range of returns of Vanguard customers are shown in blue, whilst the buy and hold benchmark returns are shown in purple. You will notice that depending on the allocation, the loss suffered ranged from -35% to around 0%. This was when markets were collapsing.
As the recovery from the sell-off took place, the right panel chart showed that the buy and hold benchmark (in purple) shift to the right as equity markets recovered. However, a lot of the Vanguard accounts (in blue) were still suffering big losses. This is because many had moved to cash or safe assets from the fear and uncertainty of the unprecedented event.
The telling chart of the study below showed that those who shifted their assets were worse off by 86% compared to what they would have received if they did nothing at all!
The market’s direction, whether up or down, should not affect a long-term investment strategy. Trading in response to market movements or news requires you to get two timing decisions correct: when to exit, and when to come in again. We have shown before that even the best market forecasters have a hit rate of approximately 70%. Stringing together a few 70% right trades eventually brings your average accuracy to below 50%, and those are terrible odds.
It is the worst time to think about changing your investment strategy. Shifting more conservatively out of fear will ensure that you miss out when markets suddenly turn such as what happened recently. The FOMO feeling you may have when staying on the sidelines would be extremely strong — especially if you’re reacting to broadcasted news.
With markets still at double-digit losses, it is one of the best times to allocate more capital to your portfolios. However, if you are really worried and you can’t simply just do nothing, then compromise and make adjustments in small increments. Instead of selling everything, do it in batches of 5 or 10% instead. At least this gives your assets more time in the market and allows you to see the effects of your actions; and because of this stepped and prolonged procedure, the market would probably be on the way to recovery by the time you are halfway through. This means that you don’t suffer as badly and miss all the returns as compared to if you had done all in one go.
If you are still worried about the state of the markets and what this means to your investments, come and have a chat with us.
