Even though Ben Franklin lived over 200 hundred years ago, his advice is timeless. During Franklin’s time, the medical cure often killed the patient. Too much blood letting and leech treatment led to fatal outcomes.
The same can be said for hyper active portfolio management. As Morgan Housel likes to say, “99% of investing is doing nothing.” Doing nothing is a strategy that is often harder to implement than the most complicated algorithm. Fear and greed are uncontrollable emotions.
Modern medicine often confronts the same dilemma that Ben Franklin experienced. Doing too much is often worse than doing nothing at all. Gilbert Welch’s article in The Wall Street Journal, “Why the Best Doctors often Do Nothing,” gives three examples of “doctor overreach”.
Often a blood sugar pill can make your blood sugar too low. A CT scan of the spine will almost certainly find something wrong with your back. This can lead to unnecessary back surgery which turns annoying back pain into a chronic condition.
Often, after finding nothing abnormal in a head CT scan, a neck ultrasound is recommended. The radiologist may find a small thyroid cancer, which most of us have if we look hard enough. This could lead to rounds of cancer treatment, which could lead to multiple negative side effects.
The connection between too much medicine and incessant portfolio management is clear. Over monitoring a portfolio, just like prescribing too much medicine, is often worse than doing nothing at all.
Fidelity conducted a study to determine its best performing individual investor accounts. Its results were shocking. The best performers were people who had forgotten they had Fidelity accounts!!
Barry Ritholtz spoke about a study about families who inherited assets that were in dispute. Often 10-20 years went by before any activity was permitted in these accounts. Studies proved this period turned out to be the years in which the portfolios garnered their highest investment returns!
It is very clear that too much investment activity is worse than simply doing nothing. Index funds have proven, over time, to outperform actively-managed funds. The main reason is because of the so called “investment friction” found in active management.
These portfolios often incur high trading costs because of frenetic trading. This, in turn, will lead to taxes of over 50% if the account is held by a high-income individual, in a taxable account, and the gains are short term.
The fees on the fund are often excessive because the fund manager is being paid to trade a great deal and try to outperform the market. These individuals are paid a premium to fulfill their often unmet expectations.
We can see how this cycle of activity leads to an inferior outcome. The investor would be better off if he bought a low activity index fund and forget about it, like those lucky people at Fidelity.
The question is: Why do people believe there is a positive correlation between investment results and the constant shuffling of assets?
The answer lies in something called “Do Something Bias.” In an excellent article by Kara Lilly called “When Less is More: Overcoming the “Do Something Bias”, the answer is revealed.
“Most people need to act even though the situation doesn’t warrant it,” says Lilly. The reason people act in this irrational manner is that it gives them the perception that they are somehow able to control something that is unpredictable. This explains the phenomena of day trading and penny stock speculation.
Just like many doctors who are too impatient to let the body heal itself, traders try to control an outcome due to their anxiety about future unknowns. In both cases, the results will often lead to much worse outcomes than just letting things be.
Often the best strategy regarding investing is to do nothing at all. Though the statistics have proven that more activity lowers returns, investors ignore it because of their incessant search to acquire the illusion of control in an uncontrollable environment.
Maybe the best solution would be to attach a blood sucking leech to the back of an impatient investor when he attempts to “time” the market. This could serve as a not-so-friendly reminder to choose the best investment strategy: Just chill out.
In the words of Warren Buffet, “Doing very little is more profitable.”