You are a goalkeeper about to face a penalty kick. You have three options to make the save. You can dive left, dive right or stay in the middle. Having looked at the stats you know the probabilities are most in your favour if you stand still.* So what do you do? You dive to the left or the right. Why? Because if you don’t and the penalty taker scores it will look like you didn’t even try. Not only will you feel worse, but the fans won’t be happy – the least you could have done is put some effort in. This bias towards action is not just an issue for goalkeepers, it is a major problem for most investors. We just cannot stop doing too much.

The penalty kick example was taken from a 2007 paper exploring the concept of action bias.[i] This idea is something of an oddity as it runs counter to a more common behavioural foible – omission bias, which is our tendency to view the harm from doing something as greater than the harm from not doing something. Whether we have a bias towards action over inaction will depend on the prevailing norms. If there is a strong expectation for action in a given situation (whether justified or not) then not doing anything will likely be viewed harshly.   

For investors it is undeniable that there is a powerful and inescapable assumption that we should be constantly active. Why is the idea so pervasive?

– Markets are changing, so must our portfolios: The relentless variability and noise of financial markets means that there is always a new theme, new story, new paradigm, which we must react to. We cannot stand still whilst everything seems to be shifting around us.

– Our behavioural biases lead us towards action: A range of behavioural traits provoke action and activity. We trade because we feel emotional (fear or greed), we trade because we overweight the importance of what is happening right now, we trade because someone is making more money than we are. The fluctuations of financial markets stimulate some of our worst behaviours.

– Underperformance is inevitable: All investors, no matter how seasoned or intelligent, will experience painful periods of underperformance whatever their approach. Even if we are adopting the right strategy, for prolonged spells it is likely to be perceived as naïve, anachronistic or just plain stupid. Our tolerance for such periods is much shorter than we think, and so we trade.

– Justifying our careers / fees / jobs:  It is really difficult to build a career by doing less than other people. How do we keep our clients if we are doing nothing when performance is poor and the returns of people doing everything are better than ours?  If we are the person in the room suggesting doing nothing, our promotion prospects are probably not looking too good. Action is a rational career choice and an institutional imperative, it’s just often not in the best interest of clients.   

– We need to tell stories: Everyone wants to hear stories. What did you do last quarter? How are you reacting to the emergence of AI? If we don’t do anything it is hard to spin a convincing narrative. We make changes so we can tell a story. (One of the strongest reasons for the pervasiveness of TAA / market timing is that it provides us with regular stories to tell).  

While there are factors that compel us towards action, there are several reasons why we should avoid it:

– Predictions are difficult: The more changes we make to our portfolios, the more we are likely to be engaging in short-term market predictions. It is reasonable to assume that the average (and above average) individual is not great at forecasting economic events nor the market’s reaction to them. We need to be right twice and most of us fall at the first hurdle.

– Whipsaw risk: It is not just that making forecasts about a complex adaptive system is a pretty difficult ask, it’s that we find ourselves reacting to each captivating narrative that the financial system spits out. Trading and tinkering incessantly. The notion that we will get this more right than wrong seems entirely fanciful.

– There is a reason for diversification: One of the primary reasons for diversification is that we do not know the future (if we did, we would only own one security). A sensible level of diversification creates a portfolio that survives different environments and where there is always something working and something lagging (this is a feature, not a bug). An appropriate level of diversity should allow us to do less.

– Negative compounding: Too much investment activity results in the incredibly powerful force of negative compounding, where the costs of our trading (a combination of fees and being wrong) act as a material long-term drag on our returns.

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The typical response to the idea of investors doing less is: “well, you can’t just do nothing”. Yet the point is not that there is never a reason to make changes – of course there are – but the default must be flipped from “what have you been doing?” to “why have you done anything?” The threshold for change must be higher.**

It seems ridiculous to suggest that thinking of ways to reduce our activity could be a route to better investment outcomes. Yet, as always, the things that seem unfeasibly simple in investing come with significant behavioural challenges. These are not impossible to overcome, we just need to find a way to do less in a system that incentivises and encourages us to do more.

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* There is a bit of a quirk here in that the best penalty taker may only strike the ball into the centre of the goal because they have already seen the goalkeeper dive. So, if the goalkeeper does stand still, the player may not kick the ball towards the centre of the goal. But let’s not let that spoil a good analogy.

** The underlying assumption here is that we have made sensible choices to start with. If we have made some terrible initial decisions, change is good!

[i] Bar-Eli, M., Azar, O. H., Ritov, I., Keidar-Levin, Y., & Schein, G. (2007). Action bias among elite soccer goalkeepers: The case of penalty kicks. Journal of economic psychology, 28(5), 606-621.

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My first book has been published. The Intelligent Fund Investor explores the beliefs and behaviours that lead investors astray, and shows how we can make better decisions. You can get a copy here (UK) or here (US).