Don’t Just Sit There, Go Ahead and Do Nothing!

Posted on March 30, 2012 at 6:32 PM PDT by

Research indicates that for most investors, tuning out the noise and sticking to their portfolio plan may be their best path to success.
These days, it’s not simply Homer Simpson that is uttering the famous TV catchphrase, “d’oh!” Some shaken investors who ran for the door in late 2008 and early 2009 are feeling stunned and bewildered at the markets dramatic recovery. As of March 9, 2009, three short years ago, the DOW sank to a shocking 6,547. Today, the DOW has boldly marched past the 13,000 mark, well above the pre-crash 11,543 close of August 2008. Investors who simply tuned out the drama and did little more than follow through with their portfolio plan consisting of low-cost diversification and disciplined rebalancing, are now rejoicing. Could such a simple approach be a key to good portfolio management?

The Roller Coaster from Hell
When it comes to roller coasters, even the youngest children know they should remain buckled in their seat until the ride deposits them safely back on terra firma. Unfortunately, for investors, the stock market allows a panicked rider to hit the eject button midcourse in spite of the risk of being thrown headlong to an ignominious demise.

According to research by Drs. Joy and Layton Smith, professors of Finance at Coggin College, this is exactly what many investors in fact did. Gripped by fear from both the market collapse of 2009 and the Flash Crash of 2010, a majority of investors abandoned their portfolio plan in a “flight to quality”. The roller coaster drama of watching a life of hard work and disciplined savings be hewn in half in a few short and horrific months was, for most, too much to bear.

Like an ultimate fighter suffering an unbearable chokehold, investors “tapped out” in a “flight to quality” – selling their stocks in favor of treasury bonds. Investors no longer cared that bond yields produced less than the annual inflation rate. They wanted off the crazy train and were in desperate need of security.

The Power of a Plan
In the late nineteen-sixties, Walter Michel, a Stanford professor of psychology performed the now historic Bing studies more commonly known as the marshmallow test. In this study, researches sat four year-old children at a table in a private room, marshmallow temptingly placed in front of them on a solitary plate. The kids where further told that the instructor must leave the room but would be back shortly. If they wanted, they could eat the marshmallow at any time, but if they waited for the instructor’s return, they would receive a second marshmallow as a reward.

On average, children lasted about three minutes before caving into desire and consuming the treat. However, thirty percent of the children lasted the entire fifteen-minute wait, receiving the reward of a double portion.

It is no surprise that after tracking of these children into adult life, those with the ability to delay gratification had greater success across many areas of life. One of the remarkable insights of the Bing studies, however, was in how children successfully in delaying gratification – something us shot delayers need help with. The high delayers approached the stress of the marshmallow temptation quite different from the majority – via something researchers called strategic allocation of attention. Instead of sitting there and getting obsessed with the marshmallow or “hot stimulus”, the children distracted themselves with other activities, like playing hide-and-seek underneath the desk, singing songs or moving about the room. Their desire wasn’t defeated – it was intentionally ignored via a distraction plan.

A simple analysis of the past three years demonstrates how this same skill worked for some investors. Take for instance a simple $1M portfolio of 50% stocks via the SPDR S&P 500 ETF, SPY, and 50% bonds via the Vanguard Total Bond Market ETF, BND. If an investor had simply made those purchases on August 1 of 2008, turned off every news source and spent the last three years gardening or playing with the grandkids, as of March 9, 2012 that investor’s account would be a robust $1,213,140 with a return of 21.32%. Not too shabby a three-year return for the worst market in modern history.

Now what happens if that same investor added the basic discipline of rebalancing according to the pre-established portfolio plan? The MarketRiders analytics engine reveals that such an investor would have been alerted to rebalance eight times over those three years. The results of the rebalancing are that the investor enjoyed account growth to $1,260,598, or a return of 26.07% – a 4.75% outperformance to the unbalanced equivalent.

Founder of the Vanguard Group and white hat, John Bogle, wrote, “Stay the course. No matter what happens, stick to your program. I’ve said ‘stay the course’ a thousand times, and I meant it every time. It is the most important single piece of investment wisdom I can give to you.”

As much as investors believe that they can anticipate the downturns and time the market, research repeatedly debunks this myth. This three-year anniversary of the downturn has once again illustrated that bailing out of even the simplest of portfolio plans is an easy way to torpedo your investment program. Yes, this turbulent journey sure felt hopeless at times, but steadfast investors understood the dictum – this too shall pass. Like the kids with the marshmallows, staying focused on the plan helped such investors resist the temptation to react, and in the end, they move a little closer to their reward of a double portion.