Dear Investor — Stay Still!
Friday, January 6, 2023 by Finshots
In every Finshots Markets, we talk about a stock or a sector. Since it’s the start of the new year, we thought we’d do something different. Maybe help you understand a facet of your investment behaviour better.
Imagine you’re the goalkeeper of your football team. A striker from the opposing team is lining up for a penalty. You enter into a staring contest. Both of you are trying to play mind games to gain an advantage.
The referee blows the whistle. The ball soars towards the goal. You dive.
If you’re picturing all this in your head, hit the pause button now.
Because let me tell you a secret…
If you really wanted to save the goal, you should’ve stayed still!!!
That’s right. When researchers analysed hundreds of penalty kicks, they found something shocking — although 39% of penalty shots head straight into the middle, only 6% of the keepers stay still. Diving reduces the probability that you can save the penalty.
This, folks, is what you’d call ‘action bias’. It’s our tendency to take action even when it’s better to sit quietly and do nothing.
There’s a reason why we started off with the football story. Because if you think about it, none of us are immune to the action bias. We can’t simply sit still. Goalkeepers dive because they want to show their team that they’re taking action. If they just stayed still and the ball went in, that would look horrible. So they take action. They dive. And it happens in the investing world too.
Financial advisors keep churning their clients’ portfolios (stocks) because they want to justify the fees their earn. Remember, these are trained professionals who’ve seen plenty of evidence to corroborate that switching funds or trying to time the market is a foolhardy exercise. But they still do it. And more often than not, financial advisors are forced to take action because of client expectations. They believe (and quite rightly) that the client prefers to see short-term action. If the market falls by 10% and the advisor doesn’t move around a stock or two, the client might just switch to a new advisor.
And DIY (do-it-yourself) investors suffer the same fate. We keep switching mutual funds. We look for the next big trend or fad and pour money into it. But more often than not, the next big thing is based on past performance. And when the cycle turns, this mutual fund might underperform. We think we made the wrong decision. So we look at which other mutual fund is doing well and quickly move money to ride the wave. We keep doing this over and over again and at the end of it all, we notice that our constant switching had dampened our returns. Our inability to keep still has hurt us. But we don’t blame ourselves. We find something else to pin the blame on. Maybe the fund manager themselves.
And the data couldn’t be clearer. When Axis Mutual Fund conducted a study of how investors behaved and the returns they made between 2003 and 2022, the infamous behaviour gap showed up loud and clear. For the uninitiated, the behaviour gap is a term made popular by a financial planner named Carl Richards to show that poor investment behaviour means that investors typically underperform the market.
And the study showed that in equity mutual funds, investors make 5% lower returns every year. Switching constantly eats away the returns.
And our behaviour extends beyond this. Forget trying to switch between funds. We believe we know exactly how the market is going to behave. We try to perfectly time the market always. If it falls by 10%, we believe it’ll fall some more. We might pull out some money to invest when it heads lower. We wait. Only to find the market rising. And we cry in anguish.
Just think back to April 2022. The Sensex (a benchmark index that tracks the 30 biggest companies in India) climbed to 60,000. People whispered that it was on its way to hit 70,000 soon. But just a couple of months later, it dropped quickly to 51,000.
How many of us took some money off the table at the high and later ‘bought the dip’? Probably no one.
Sure, we know the history. We know that trying to time the market hasn’t worked. But we trick ourselves into believing that this time will be different. Why? Because if it is, we’ll be better off for it. Also, we don’t like randomness. We want some certainty. We think we know what’s happening. So we continue to attempt to time the market at every opportunity we get.
Imagine you started investing in the Sensex in 2000. Over the past 2 decades, you would’ve lived through the dot-com crisis, surprise changes in governments, the global financial crisis, the European debt crisis, the taper tantrum, demonetisation, and the pandemic. That’s not even an exhaustive list.
But what if you decided to time the market during this period? You tried exiting and entering at various periods. And you stupidly missed some of the best performing days in the market in this quest to catch the bottom?
The end result?
If you’d stayed invested, ₹1 lakh worth of your investment would’ve grown to ₹11.67 lakhs. But if you’d missed just 10 of the best days in these 22 years, you would be left with just ₹5.21 lakhs. That’s a huge difference.
So remember, doing nothing is a choice as well. And often, it’s the best choice.
But there’s another reason why we get up to all this nonsense. And it’s not just about our innate need for control. It’s what Charles Kindleberger, an American economic historian, pointed out: “There is nothing so disturbing to one’s well-being and judgment as to see a friend get rich.”
Or put another way, we want to get rich before our peers. We think that taking action will maximise our chances. But it doesn’t happen. Or it doesn’t happen to everyone at least. You could get lucky and strike gold. Or you could be like the person who sold his house and bought Tesla stock at its very top only to find your wealth evaporate by 60% the following year.
Sure, you might read this story and nod along. But it’s going to be tough to fight the demon in your head every time. Our action bias comes in the way every damn time. And the only way to really fight it is to automate your investments and let your money work hard for you. That should be your goal in 2023.