Don’t Just Do Something, Stand There

July 2018

People have a hard time sitting still. “All of humanity's problems stem from man's inability to sit quietly in a room alone,” said Blaise Pascal. Perhaps this has never been more evident than the present day: the next time you see someone sitting alone, observe how long it takes before a cellphone is pulled out as a distraction.

Here’s how bad we are at doing nothing: a study has shown that we prefer to give ourselves painful electric shocks than to sit alone quietly. Perhaps the present-day equivalent to this shock study is that we prefer to pull out our cellphones and be pained by what we read on social media.

Investors Aren’t Sitting Still

The following chart shows that trading activity at U.S. direct investing brokers is at decade highs. This news didn’t surprise us, as the increased trading activity has coincided with rising tech stocks. We suspect individual investors have been thinking to themselves:

Tech stocks are rising!
I need to do something!
Trading is something!
Ergo, I need to do trading!

Please excuse us for the unsolicited advice about how to live your life, but you shouldn’t give yourself painful electric shocks. Similarly, (although we won’t apologize for giving investment advice) you shouldn’t increase your trading frequency simply because you missed out on a previous market rally.

How to Be the Best Investor

There’s an anecdote that a few years ago, the investment services company Fidelity wanted to figure out what type of clients had realized the best returns over the previous decade. The company reviewed its clients’ accounts for the decade between 2003 and 2013 to see what the common thread was. What it found was that the clients with the best performance didn’t share similar asset mix, nor did they all own the same funds. Instead, the best performing accounts were owned by people who totally forgot about owning the accounts.

Investors can be their own worst enemy. The urge to do something to improve performance often results in jumping in to and out of whatever is or was in vogue. This, in turn, results in investors chasing performance and generating unnecessary trading costs by buying when they should be selling and selling when they should be buying.

For example, the following chart shows the flow of funds in to and out of U.S. mutual funds versus performance of the S&P 500 Index. You can see that during the market selloff earlier this year, ETF investors rushed for the exits. Call us crazy, but when the markets selloff and get cheaper, we prefer to be buying, not selling.

We originally presented this next chart a few months ago and believe it’s useful to share again. It shows that 2018 is on pace to have the largest inflows to tech-focused funds since the dot-com bubble. Why do we think this is the case? Because tech companies have been on such an incredible run in recent years. Again, we believe this is an example of investors chasing historical performance, without considering what’s important: what’s going to happen in the future.

What Will We Do About It?

We will never make investment decisions based on a fear of missing out. We invest to generate absolute – not relative – returns. Whether major indices are up 5%, 10%, or 50%, it won’t alter our investment process.

Not all fund managers are as lucky to have a mandate to generate returns in the same manner. Those who try to generate relative returns have had a challenging year in 2018. As the Wall Street Journal points out, “This year, managers not invested in tech stocks should be polishing their résumés.” But as we’ve pointed out before, outcome bias is a poor way to evaluate managers’ investment decisions.

Instead, we’re going to stick to what we believe works over the long term: searching for value investments. If we can’t find any, we’re content to sit on our hands. It may be hard to do nothing, but sometimes nothing is better than something.