Embrace Laziness: The Best Approach to Investing
This seems like an unlikely recommendation. Nor does it sit well with us. “Don’t just sit there; do something!” Isn’t that the usual guidance we receive? However, action doesn’t seem to work so well with respect to investing.
First, some context regarding that quotation, above. Fidelity Investments is a significant force in the world of investment services. In Canada, we know them mostly through their mutual fund offerings, but in the US they are also a major provider of a type of employer-sponsored defined contribution plan known as a 401(k). If you were a participant in that type of pension scheme, it is quite likely that there was an arrangement in which a portion of your paycheque was automatically deducted and contributed into the plan. That portion was also probably matched by your employer. As is often the case, people move on from one employer to another. Rather than transferring the 401(k) to a Rollover Individual Retirement Account (IRA), as one might transfer a defined contribution pension plan to a locked-in RRSP in Canada, it seems that a number of people have simply moved on to a different employer and forgotten about their old 401(k).
It turns out that Fidelity did a study of the 401(k) accounts in their custody, discerned which ones had been “orphaned,” and found that those accounts were more likely to have outperformed accounts in which the owner was aware of and actively engaged in their investments.
A Portfolio is Like a Bar of Soap
“A portfolio is like a bar of soap. The more you touch it, the smaller it gets.” This adage says in two pithy sentences what the story from Fidelity illustrates. The more actively you get involved in managing your investments, the more likely you are to have poor investment returns. In 2018, the stock markets did not do particularly well. The S&P 500 stock index, often cited as a proxy for the US market, lost 4.38% that year. On average, individual investors lost more than double, 9.42%.
In 2013, I served a segment of active investors. I remember receiving a phone call from a woman who said that she found it difficult to make money “in this market.” If she had simply bought an index fund that tracked the S&P 500 index at the beginning of the year, she would have earned a 30% return. Instead, her return was in the neighbourhood of 10% because she was actively trying to “beat the market.”
Should I do nothing at all?
So, is the best policy when it comes to investing to do nothing at all? It depends. Assuming you have established a proper balance of investments among equities, fixed income and cash or cash-like assets, you may not have to do much at all, except periodically add new money to your account over time. If you are putting it into a balanced fund that combines all the components into one investment vehicle it really is a very simple process. If, on the other hand, you have chosen a combination of investments from different categories that need to be invested in individually, you may have to rebalance periodically because, as time passes, some investments will do better than others. But you may not need to make those adjustments more often than once a year.
Overcoming the Bias Toward Action
Forget About It?
As has often been pointed out, investing is as much about human behaviour as it is about the performance of the underlying investments. Forgetting you even have an investment account is one way to overcome a bias toward action, but it is probably not the best choice. Eventually, you are going to want to withdraw those funds in order to pay for expenses when you are no longer able or willing to work for an income. You will need to remember that you have that investment.
A Single Fund Solution
I am not necessarily advocating for this as the best solution, but a simple global balanced fund can do the job for many investors. Depending on your time horizon, your risk tolerance, your need for a certain level of growth, and how investing fits into your overall financial picture, you can buy a balanced fund that is tilted more toward growth, meaning equities or stocks, or more toward safety, that is fixed income, bonds or cash-like investments like GICs. You can find such funds in both the Exchange-Traded Fund world and among mutual funds.
The benefit of a single fund solution is that you don’t have to worry about rebalancing. For example, if the fund company indicates that a particular mutual fund or ETF targets a 60% equity, 40% fixed income balance, then periodically the fund company will make sure that the fund stays on target.
A Portfolio of Several Funds
Sometimes you simply cannot get the mix that makes sense of your needs in a single fund. In that case, you will have to mix together a group of funds. This is certainly not a bad thing to do, but it does require more work on your part. Unless you are working with an investment advisor who does all the trading and rebalancing for you, you will have to take care of that on your own.
Good performance can be just as much of a challenge as bad performance in keeping such a portfolio in proper balance. Imagine you have a portfolio of four funds worth a total of $100,000.
At the beginning of the year you had 40% in a bond fund and the remaining 60% split it up among three different equity funds. As the year wore on, the bond fund did surprisingly well and so did the US equity fund but the Canadian and International funds lost money. Overall, you are up for the year, but only by 1.26%. You know that the balance you had at the beginning of the year still makes sense, so that means you need to sell off a portion of your successful Bond and US equity funds and buy into the losing Canadian and International funds. And herein lies the challenge. Can you handle rebalancing “into the pain,” that is, selling your winners and buying your losers? One way to resolve that problem is to put a rebalancing date into your calendar. On the first business day of each new year, you will rebalance, regardless of where your investments stand. It still means you have to make the decision, but if the calendar tells you it’s time, it might not be as difficult than if it is left fully to your discretion.
Systematic Investment Plan (SIP)
Another way to mitigate our bias toward action is to set up a systematic investment plan. Mind you, this can generally only be done with mutual funds, not ETFs. Imagine you have a portfolio with the same allocations as the one I have described above. At the beginning of the year, you opened a new Tax-Free Savings Account and deposited $6,000. At the beginning of each month, you pre-arrange for a contribution to the TFSA of $500 and an automatic investment of the $500 in proportion to the Target Balance.
Each month the value of each position in the portfolio will fluctuate, but your monthly contributions will help to mitigate that fluctuation because they will be invested in your desired proportions. Even so, the investments will drift away from your target balance over time. The benefit, however, is that you don’t have to worry about making investment decisions for yourself. It will all be done automatically.
Investing is for the Long Term
So much of investing is presented as a variation on gambling. You go to the track, put your money on a horse and hope it’s a winner. If you want to gamble, that’s up to you. However, investing for your retirement (RRSP), for your children’s post-secondary education (RESP), or for the benefit of a disabled family member (RDSP), to name three different situations, should not be about seeking entertainment value. Investing is about participating in an institution that has shown its ability to grow wealth over time so that you can have a degree of financial contentment that you would not otherwise have. Investing is best done when it can be safely ignored for weeks or months at a time.
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Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, tax, or legal decisions.