The Hard Part is Staying Still

Source: Blackrock

Back on August 5^th, Japan’s stock market lost more than 12% in a single trading day. While that was happening, the US government released a jobs number that made people think the Fed’s monetary policy was too restrictive.  And if the monetary policy was too restrictive, maybe tech stocks were priced too high.  And if that didn’t scare people enough, Buffett was reported to have sold a bunch of stock which reinforced the belief that further declines were imminent.

In response to all of this, the Dow dropped 2.6%, the Nasdaq lost 3.43%, the S&P 500 slid 3% and trading activity in 401k accounts spiked to 8.3 times their normal volume.

According to Rob Austin, the person in charge of monitoring this type of activity for the third largest 401k provider,

“People overwhelmingly sought safety with nearly all net inflows going to Stable Value, Bond Funds, and Money Market accounts.”

Abandoning long-term plans out of fear is never a good idea and this time was no exception. 

The following day, on August 6^th, Japan’s stock market jumped 10.2% and the S&P started a climb that would take it 9.7% higher by month end.

The details of the story are always different, but the general theme is always the same.  Investors get scared, sell their stocks when they are down, move to cash until things feel safer and make themselves worse off as a result.

Below is an old chart from Vanguard showing what happened to investors that got out of the market from March – July of 2020.   

Source: Vanguard

Different events, but the same human response. 

But You Have to Do Something!

Imagine you are the goalie in the picture up top.  You are standing there, waiting for the opponent to take a free kick, and someone tells you to just stand there.  Don’t try to dive right or left.  Just stand there. Statistically, that strategy of staying in the center has the highest odds of success but what happens when it doesn’t work?  You feel like an idiot and the crowd hates you. 

On the other hand, you think, if I dive and I’m wrong, everyone will at least see that I tried. And if I dive and I’m lucky enough to be right, they’ll call me a hero!

This is why goalies dive and investors trade even though it is in neither of their best interests.

Interesting Studies

If you are still reading hoping for more evidence that reactionary trading is bad, here are some studies highlighted in Daniel Crosby’s, The Laws of Wealth: Psychology and the Secret to Investing Success” (Harriman House, 2016).

·         A team at Fidelity set out to examine the behaviors of their best-performing accounts to isolate the behaviors of truly exceptional investors. When they contacted the owners of the best performing accounts, the common thread tended to be that they had forgotten about the account altogether.

·         Vanguard, also examined the performance of accounts that had made no changes versus those that had made tweaks. Sure enough, they found that the “no change” condition handily outperformed the tinkerers.

·         Further, Meir Statman [ in his book “What Investors Really Want” (McGraw-Hill Education, 2010)] cites research from Sweden showing that the heaviest traders lose 4% of their account value each year to trading costs and poor timing. These results are consistent across the globe: Across 19 major stock exchanges, investors who made frequent changes trailed buy-and-hold investors by 1.5 percentage points per year. 

·         Perhaps the best-known study on the damaging effects of action bias also provides insight into gender-linked tendencies in trading behavior. Terrance Odean and Brad Barber, two of the fathers of behavioral finance, looked at the individual accounts of a large discount broker and found...men in the study traded 45% more than the women, with single men out-trading their female counterparts by an incredible 67%. Mr. Barber and Mr. Odean attributed this greater activity to overconfidence, but whatever its psychological roots, it consistently degraded returns. As a result of overactivity, the average man in the study underperformed the average woman by 1.4 percentage points per year. Worse still, single men lagged single women by 2.3% — an incredible drag when compounded over an investment lifetime.

The next time the market has a big drop, and it certainly will, remember the words of Vanguard’s founder, Jack Bogle, “Don’t just do something, stand there!”

Bonus Content:

If you’ve made it this far, here is a picture of my 4^th grader and I at last weekend’s football game. 

I’m an assistant coach but I’m not all that helpful.  The other coaches are former NFL players that actually know what they are doing, so I let them do all the teaching and strategizing.  My main function is to make sure the chin straps are on, the mouth guards are in, and each kid gets enough plays.