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«Those who invest passively should also remain passive»

Action Bias: Peace of Mind Pays Off

Felix Niederer13.09.2017

Too much trading spoils your performance. Here you will learn why you should not only invest passively. But also why it is better to remain passive even after entering the market.

Sell when prices have fallen – buy more of what has just risen spectacularly: Far too many investors react violently to fluctuations in share prices. Too violently. Because reacting is anything but helpful. Those who trade too much spoil their performance.

Unfortunately, this is very human: Those who are confronted with complicated situations tend to take action. In science, this is called «action bias». It describes the human urge to do something in complex situations, even though the consequences of the action are unforeseeable, senseless or even harmful. Whether attacking or fleeing: Action is what matters!

If You don't Jump, You're not a Goalie

We don't only see this push on the markets. We also see it in football, during a penalty kick, for example. All the spectators in the stadium and the players concentrate on one thing: The face-off between the goalkeeper and the opposition player taking the penalty.

28 per cent of all balls shot end up in the middle of the goal. So it would make a lot of sense for the goalkeeper to just stay in the middle. As he would have a huge chance of saving a penalty. Imagine that: More than one in four penalties saved!

In practice, however, goalies decide to dive to the left or right of the goal in about 90 per cent of all cases, thereby missing more often than necessary.

Where does the Pressure Come From?

What if the goalkeeper stood still – and the ball went in next to him? He would then look like a slacker. The spectators will boo him. His teammates will accuse him of not having done enough and for spoiling the match bonus. This is what he must fear.

So he jumps, despite the statistical evidence (At least he will have displayed full commitment).

Always Fully Committed?

Many financial professionals also show full commitment. Asset managers or portfolio managers in funds with active management show time and again how active they are – sometimes even more active than private investors.

Nobody wants to get out of a market too late. No one wants to miss the chance for additional returns. Yet most fluctuations on the stock markets are rather short-term and are not really relevant for investors with a long-term investment strategy.

But asset managers build customer loyalty when they demonstrate commitment. They are then the ones in charge, who turn the tide in crises. Oftentimes this is exactly how they earn their money: From fees for as many shifts as possible.

Nobody Beats the Market

Investor behaviour has also been thoroughly researched. The outcome is clear: No one beats the market in the long term. Investors who regularly pay active managers for rebalancing and to spend a lot of money on transaction costs reduce their returns.

That is why exchange traded funds (ETF) have become so popular in recent years: They exactly replicate their respective market segment. All changes in the individual stocks are automatically reflected in the price. Since there is no need to pay for active management, they are extraordinarily cheap. ETFs do not require active management, so therefore this investment style is called passive.

If you go Passive, then go Passive all the Way

If you go for the passive ETFs when it comes to investment instruments, then you should also behave passively when it comes to your portfolio. Invest passively and stay passive – and resist the urge to trade. This urge will seriously tempt you, there’s no doubt about it. But it pays to stay cool.

Determine at the beginning what proportion each asset class should get in your portfolio and stick to that strategy. The only tactical action that has been proven to pay off is regular rebalancing.

Rebalancing ensures that the asset classes are balanced exactly as you strategically determined them to be at the beginning. Even after price fluctuations (Incidentally, this is completely anti-cyclical: Rebalancing involves selling what has done particularly well and buying more of what could have performed better. This is the opposite of what the impulse of action bias is suggesting to you).

If you let True Wealth manage your portfolio, you don't have to do anything yourself when it comes to rebalancing. We do it automatically and on a regular basis for you. You do not incur any transaction fees (brokerage fees) as they are already included in the asset management fee.

Steady Without Looking

This way you are a decisive step ahead of the goalkeeper: You don't even have to stand in the goal yourself. You simply leave it to us to stand firm for you.

And yes, we understand that sometimes you want to see what's going on. In your True Wealth account you can see how well things are going. With a test account this is completely free of charge and means you're not risking your own money.

Disclaimer: We have taken great care with the content of this article. Nevertheless, we cannot exclude the possibility of errors. The validity of the content is limited to the time of publication.

About the author

author
Felix Niederer

Founder and CEO of True Wealth. After graduating from the Swiss Federal Institute of Technology (ETH) as a physicist, Felix first spent several years in Swiss industry and then four years with a major reinsurance company in portfolio management and risk modeling.

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