Investing is not always about what you do (i.e. choosing where to invest), it’s equally about what you do not do. In many cases, doing nothing is the best strategy. One of the primary, less mentioned responsibilities of a Financial Planner is to protect clients from themselves, especially in the short term when they are panicking and wanting to move investments around. There have been several studies done on the impact of making emotional investment decisions. In particular there is one study known as the Dalbar study. It highlights that the average stock investor earned 5.96% per year from 2001 – 2020. However, the stock market itself (i.e. S&P 500) earned 7.47% per year. Why the disparity?
The reason is because investors panicked and moved their money around. Essentially, they “bought” when times were optimistic and “sold” when times were pessimistic. In other words, this was a buy high / sell low strategy. Bad idea!! They would have been better off doing nothing. In fact, a $100,000 investment would have turned into only $318,000 for the average investor. But if left in the stock market and not moved around, the same investment would have turned into $422,000. Quite a difference for doing nothing!
Economics is often times used as a crystal ball to determine where to invest. And as a result, people often times turn to economists for their investment advice. However, have you ever seen two very intelligent, well educated economists differ in their recommendations? How can this be? It happens all the time. NO ONE HAS EVER BEEN ABLE TO CONSISTENTLY PREDICT WHEN AND WHAT TO BUY AND SELL AT THE RIGHT TIMES!!!! Many studies have proven that market timing does not work over the long term. So, STOP LISTENING TO THE ECONOMISTS (and the media)!!!.
Our firm is essentially agnostic as to what’s going on in the economy. You see, in my opinion, there are two schools of thought on this matter: (1) Those who invest based on what economists say and (2) Those that don’t. Our firm falls into the latter category. This is what is known as “passive investing”. Don’t let the word “passive” fool you into thinking that it means “weak”. In fact, it’s just the opposite. As mentioned above, doing nothing is often times the best strategy. This restraint requires a great deal of “strength” because you will be on the road less traveled (unlike the average stock investor). Think about it this way. Does it require greater strength to lash out at someone in anger or does it require greater strength to bite your tongue (i.e. do nothing). I think you know the answer.
It can also seem that “passive” means “do nothing”, which is not true. For example, at our firm we actively do the following:
(1) We continually review the landscape of investments and utilize ones that suit our investment strategy.
(2) Many of the investments (mutual funds and ETFs) we use have a defined process to “actively” buy stocks and bonds so that you can benefit from the best price.
(3) On a daily basis, we review every investment account to see if any of the investments have deviated too far from target. If so, we will buy or sell. This is a forced way for us to buy low and sell high!
A passive investment strategy will primarily utilize passive investments. Passive investments are those that do not have a manager who is trying to predict where to invest next. Instead, passive investments generally represent a specific category (i.e. U.S. Large Company Stocks, International Stocks, U.S. Bonds, etc.). And as a result, a passive investment approach will involve investing in many different categories in an effort to spread out the risk. This is what diversification is all about.
The vast majority of evidence shows that passive investments outperform active investments (those with a manager). And to top it off, passive investments are typically much less expensive.
By the way, a passive approach whereby you invested into the U.S. Stock Market (i.e. S&P 500) has never lost money in any 16 year rolling period dating back to 1926. The moral of the story – don’t get caught up in the short term.
If you have any questions or comments about how to invest, please share them below.
Brad E.S. Tinnon
CERTIFIED FINANCIAL PLANNER™
Photo courtesy of Duncan Rawlinson