The markets met the past quarter with more sanguinity. We had a dip in February, but the markets ended the quarter mostly flat. There are many positive economic signals: job numbers continue to improve, economic growth was revised upward for the previous quarter, the EU hit its highest consumer confidence in half a decade, and housing numbers are on track. For the most part, the market brushed aside events that at other times might cause significant downward movement, like the Russian invasion of Crimea. Many Wall Street analysts are predicting a multi-year spell of lowered stock volatility. That may happen, but it’s certainly not something one can predict with any accuracy. So, thinking about all those professional investors that are basing their strategies on those predictions, I wanted to touch on two of the advantages independent investors hold over Wall Street: the freedom to admit uncertainty and the absence of pressure to react to every market event.
“I don’t know” is an option.
The world is complicated. So complicated that there are things we will never know. Wall Street analysts, however, often feel they cannot say, “I don’t know.” They’re hired to know. When one is asked to have an opinion about things that are inherently unknowable, one is forced to fabricate answers. Watch CNBC reporters ask their guests where the market is going to be a year from now and you will always get an answer. As I’ve said before, that answer usually describes perfectly the investment cycle that just happened, and bears no resemblance to the cycle of the coming year. Analysts are paid to have an opinion, and they would love to share it with you. As the economist J.K. Galbraith said, “Pundits forecast not because they know, but because they are asked.”
When people are treated as experts (even if it’s an expertise based on the unknowable), investors begin to take their opinions seriously. That can be dangerous, because having confidence that random and unknowable events are predictable leads to investor misbehavior. An investor that understands what he or she does not know can make more rational decisions.
When no action is required, inaction is beneficial.
Knowing when to act and when not to act is one of the most important skills for successful investors. Study after study has shown that those that buy and hold vastly outperform active traders over the long-term. For those without access to a trusted independent investment advisor, buying a portfolio of stocks or index funds and not touching it for years is a sound way to invest.
According to Vanguard’s Center for Retirement Research, only 3% of Vanguard customers cashed out their stocks during the 2008/2009 financial crisis. This is at a time when Wall Street professionals were selling at ever increasing rates. That means that the average amateur investor took full advantage of the rebound and outperformed many Wall Street professionals.
Bloomberg reported that when the S&P 500 bottomed out 70% below today’s prices, every Wall Street trader interviewed predicted a big rebound. But when the reporter asked how the traders were invested, the response was “in cash.” They said it was because they couldn’t afford to have another down month. The coming rally didn’t change their behavior, because they didn’t know how far off it was and short-term considerations were driving their investments. If the rally took another few months to arrive, they didn’t want to go to their bosses, or their investors, explaining why they lost money again. So they hid in cash, knowing full well that they would lose out on part of the rebound (which they did).
There is a lot of pressure on professional investors to do something. When the market moves dramatically in one direction or another, a Wall Street trader’s boss or investors will ask why he isn’t reacting. The common refrain is: “Bad things are happening to my portfolio, do something.” So they trade, rotate, take money off the table, pour cash into equities, worry, and overreact. The person who bought an S&P 500 index fund 30 years ago and checked his brokerage statement for the first time yesterday could legitimately count himself one of the top investment managers on Wall Street. Knowing when not to act is just as important as knowing when to act. The key is to put in place a long-term plan and trade when the plan’s criteria are met. Buy when your value metrics are met and sell when value has dissipated.
Independent investors had something Wall Street couldn’t dream of in 2009: the ability to ignore the sorts of short-term pressures put to bear on Wall Street. Many smaller investors spend lots of time complaining about the advantage Wall Street has over them (insider trading, high-frequency trading, etc.), but independent investors hold some key advantages that can give them a huge leg up on Wall Street.