Wall Street: Where Less is More

“Never underestimate the power of doing nothing.” – Winnie the Pooh

“Far from idleness being the root of all evil, it is rather the only true good.” – Soren Kierkegaard


Imagine a world where you could gain more knowledge by reading fewer books, see more of the world by minimizing travel and get more fit by doing less exercise. Certainly, a world where doing less gets you more is highly inconsistent with much of our lived experience, but is just the way Wall Street Bizarro World operates. If we are to learn to live in WSBW (and we must), one of the primary lessons to be learned is to do less than we think we should.

The psychobabble term for the tendency toward dramatic effort in the face of high stakes is “action bias.” Some of the most interesting research into action bias comes to us from the wild world of sports – soccer in particular. A group of researchers examined the behavior of soccer goalies when faced with stopping a penalty kick. By examining 311 kicks, they found that goalies dove dramatically to the right or left side of the goal 94 percent of the time. The kicks themselves, however, were divided roughly equally, with a third going left, a third right and a third near the middle. This being the case, they found that goalies that stayed centered had a 60 percent chance of stopping the ball, far greater than the odds of going left or right.

So why is it that goalies are given to dramatics when relative laziness is the most sound strategy? The answer becomes more apparent when we put ourselves in the shoes…er…cleats of the goalie (especially of goalies who live in countries where failure on the pitch is punishable by death). When the game and national integrity are on the line, you want to look as though you are giving a heroic effort, probabilities be damned! You want to give your all, to “leave it all on the field” in sportspeak and staying centered has the decided visual impact of stunned complacency. Similarly, investors tasked with preserving and growing their hard earned wealth do not want to sit idly by in periods of distress, even if the research shows that this is typically the best course of action.

A team at Fidelity set out to examine the behaviors of their best performing accounts in an effort to isolate the behaviors of truly exceptional investors. What they found may shock you. When they contacted the owners of the best performing accounts, the common thread tended to be that they had forgotten about the account altogether. So much for isolating the complex behavioral traits of skilled investors! It would seem that forgetfulness might be the greatest gift at an investor’s disposal.

Another fund behemoth, Vanguard, also examined the performance of accounts that had made no changes versus those who had made tweaks. Sure enough, they found that the “no change” condition handily outperformed the tinkerers. Meir Statman cites research from Sweden showing that the heaviest traders lose 4 percent of their account value each year to trading costs and poor timing and 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 something that surprised them at the time.

The men in the study traded 45 percent more than the women, with single men out trading their female counterparts by an incredible 67 percent. Barber and Odean attribute 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 percent – an incredible drag when compounded over an investment lifetime.

The tendency of women to outperform is not only seen in retail investors, however. Female hedge fund managers have consistently and soundly thumped their male colleagues, owing largely to the patience discussed above. As LouAnn Lofton of the Motley Fool reports, “…funds managed by women have, since inception, returned an average 9.06 percent, compared to just 5.82 percent averaged by a weighted index of other hedge funds. As if that outperformance weren’t impressive enough, the group also found that during the financial panic of 2008, these women-managed funds weren’t hurt nearly as severely as the rest of the hedge fund universe, with the funds dropping 9.61 percent compared to the 19.03 percent suffered by other funds.” Boys, it would seem, will be hyperactive boys, but few could have guessed the steep financial cost of action bias. At Nocturne Capital, we believe that active management is most powerful when it's...well...not all that active. 

For more great content on the counterintuitive truths found in "Wall Street Bizarro World", please check out "The Laws of Wealth" by Nocturne founder Dr. Daniel Crosby

Wall Street: Where the Future is More Certain than the Present

Suppose I asked you what you would be doing in 5 minutes. Odds are, you would be able to answer that question with some high degree of certainty. After all, it will probably look a bit like what you are doing at the time you were asked. Now, let’s move the goalpost back a bit and imagine that I asked you what you would be doing five weeks from now. It would certainly be exponentially harder to pinpoint, but your calendar may give some clues as to how you will be engaged at that time. Now imagine you were asked to forecast your actions five months, five years or even fifty years from now – damn near impossible, right? Of course it is, because in our quotidian existence, the present is far more knowable than the distant future.

What complicates investing then, is that the exact reverse is true. We have no idea what will happen today, very little notion of what next week holds, a slight inkling as to potential one-year returns, but could take a pretty solid stab at thirty years from now. Consider the long-term performance of stocks by holding periods:

Range Of Returns on Stocks: 1926 to 1997

 Holding Period    Best Return    Worst Return

1 Year                     +53.9    %    -43.3    %
5 Years                   +23.9    %    -12.5    %
10 Years                  +20.1    %    - 0.9    %
15 Years                  +18.2    %    + 0.6    %
20 Years                 +16.9    %    + 3.1    %
25 Years                  +14.7    %    + 5.9    %

Over short periods of time, returns are nearly unknowable. Stocks are up about 60 percent of the time and down about 40 percent of the time, but the highs and lows are both very dramatic. Over a time period more reflective of a long-term investment horizon, however, the future becomes far more certain. Returns average just over 10 percent per year, with the worst case being around 6 percent and the best case being nearly 15 percent. Not so scary anymore, but it does require a fundamental rethinking of reality, something that seems not to be happening. As statistician extraordinaire Nate Silver says in The Signal and the Noise:

“In the 1950s, the average share of common stock in an American company was held for about six years before being traded – consistent with the idea that stocks are a long-term investment. By the 2000s, the velocity of trading had increased roughly twelvefold. Instead of being held for six years, the same share of stock was traded after just six months. The trend shows few signs of abating: stock market volumes have been doubling once every four or five years.”

Intuition tells us that “now” is more knowable than “tomorrow” but Wall Street Bizarro World (WSBW) says otherwise. As Mr. Silver points out, more access to data and the disintermediary effects of technology make our tendency toward short-termism even greater. But the growing impatience of the masses only serves to benefit the savvy investor. As Ben Carlson says in A Wealth of Common Sense, “Individuals have to understand that no matter what innovations we see in the financial industry, patience will always be the great equalizer in financial markets. There’s no way to arbitrage good behavior over a long time horizon. In fact, one of the biggest advantages individuals have over the pros is the ability to be patient.”

For much, much more on applying behavioral finance to the management of both self and wealth, please check out "The Laws of Wealth" by Nocturne Capital founder, Dr. Daniel Crosby.