Ready to Take Action on Your Portfolio? Read This 1st

Paul Summers looks at why our tendency to act rather than do nothing can often lead to worse investment returns.

The Motley Fool

You’re a goalkeeper about to face a penalty kick. The speed the ball is likely to travel at means you must decide how to respond before it’s struck. More likely than not, you’ll choose to dive to your left or right. That’s unfortunate. In an analysis of 286 penalty kicks taken in elite matches, it was found that keepers saved a third of penalties by standing still. This compared favourably to when they jumped to the left (14.2% saved) and to the right (12.6% saved).

Goalkeepers shouldn’t beat themselves up. The need to do something is called action bias and it has a long history. Back in prehistoric times, this tendency served us well. Far better to run with the herd than risk being gobbled up by a predator. In the modern day however, this can be counterproductive. Nowhere is this more evident than with investing.

Why it’s so hard to stay still

A great example of action bias was the aftermath of the EU referendum vote. Back in June, a lot of people jettisoned excellent companies from their portfolios thanks to the uncertainty gripping the market. Like our ancestors, they sensed a threat, saw what others were doing and responded accordingly. So far, so human.

Unfortunately, this lost a lot of people a lot of money. Others, sensing a market overreaction, began hoovering up the shares and the markets rebounded. Even if the first group repurchased their shares (probably at a higher price), they still paid up in commission costs and stamp duty to do so.

This is one instance of the temptation to act. Investors also have to contend with the scarcity effect (“What if this is my last chance to buy cheap?”), boredom (“When will something happen to the share price?”) and the desire for quick returns (“Need bigger profits this month.”)

This doesn’t mean that acting is always a bad idea. Hindsight allows us to see that those with shorter investing horizons may have been better off selling their shares in Tesco, Restaurant Group or Sports Direct. The point is we need to distinguish sound investing decisions from the urge to do something, anything, with our investments.

Build a quiet room

The first way of defending ourselves against action bias is to recognise our susceptibility to it. If you’re planning to make alterations to your portfolio, question your reasons for doing so. If this happens during times of market turmoil, recognise that standing still while others fret won’t kill you.

Next, focus on buying a diverse group of resilient companies with competitive advantages. They’ll have long histories of growing earnings and delivering high returns on capital employed (ROCE). If we set out to buy the right companies for a fair price, we reduce the need to act further down the line.

To further reduce this habit, we could also pay a little less attention to how the markets are behaving.  If this makes us uncomfortable, we could sign up to news alerts from the companies we own. This way, we neatly avoid lots of irrelevant, panic-inducing noise, allowing us to make informed, stock-specific decisions.

French mathematician Blaise Pascal once reflected that a lot of our problems “derive from not being able to sit in a quiet room alone.” Know when to occupy yours.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Paul Summers has no position in any shares mentioned.

More on Investing

Sliced pumpkin pie
Dividend Stocks

2 Delicious Dividend Stocks I Plan to Add to My TFSA in October

These dreamy dividend stocks can provide you with endless dividends in your TFSA. And it's why I'm considering them right…

Read more »

The letters AI glowing on a circuit board processor.
Tech Stocks

Is Nvidia’s Growth Sustainable?

Nvidia stock soars 1,069% in 2 years. Is this AI chip titan's growth sustainable, or are we witnessing a bubble…

Read more »

Canada day banner background design of flag
Investing

3 Growth Stocks to Buy Now and Hold Forever

These Canadian growth stocks have delivered stellar returns but still have room for growth and can deliver solid capital gains…

Read more »

Hand Protecting Senior Couple
Dividend Stocks

TFSA Pension: How Couples Can Earn $9,500 per Year in Tax-Free Passive Income

This investing strategy can reduce risk and boost returns.

Read more »

calculate and analyze stock
Investing

If You Had Invested $1,000 in Dollarama Stock 5 Years Ago, This Is How Much You’d Have Now

As Dollarama's share price consistently grows year over year, here's how much long-term investors are making owning the top stock.

Read more »

shopper buys items in bulk
Dividend Stocks

9.9% Dividend Yield? I’ll Be Buying This TSX Passive-Income Stock in Bulk

Why make investing complicated? This ETF makes earning monthly income easy.

Read more »

worker holds seedling in soybean field
Investing

Got $10,000? Here’s How It Could Become $100,000

Investing in smart small cap-stocks could be a faster way to multiply your wealth.

Read more »

Canadian dollars in a magnifying glass
Investing

2 High-Yield Dividend ETFs to Buy to Generate Passive Income

These two high-yield Hamilton ETFs pay monthly and offer exposure to real assets.

Read more »