February 9, 2016
February 9, 2016
My driving philosophy has always been to be active and aggressive. On a recent drive to San Diego, I assertively weaved my way through traffic on the I-5, convinced that I would arrive more quickly than those complacent drivers that inexplicably tolerate the boredom of staying in one lane. On this particular drive, however, I noticed a blue Subaru that kept pace regardless of all my self-perceived brilliant and opportunistic lane changes. Frustrated, I forced a lane change at the exact wrong time, which resulted in getting stuck in a congested line of never-ending eighteen-wheelers. The blue Subaru unassumingly plodded by never to look back. Aided by the type of reflective state of mind that can come from hours on the road, this experience led to a driving epiphany. I should drive the way I invest.
When it comes to investing, I behave like the blue Subaru. I believe in staying the course and understand the risks of being overly active – trying to time the market or pick the “winning” stocks. Being an active investor is risky in the same sense that being an aggressive driver can be. Constant maneuvering can lead to bad results. Guessing correctly on a one-off basis is certainly possible, but doing so time and time again is extremely difficult and one poorly timed or selected trade can undo years of good investment returns.
Further, similar to the costliness of aggressive driving – fuel inefficiency, additional wear and tear on the car, and greater exposure to an accident – active investing can be expensive. Active fund managers (i.e., fund managers that attempt to outperform the market using aggressive trading strategies), for example, tend to charge higher fees than their more passive counterparts. Excessive trading (known as high turnover) within these funds may also generate significant transaction costs that further erode returns. Even worse, if the trades occur in a taxable account, such as an individual or trust account, they can lead to the recognition of costly short-term capital gains.
For these reasons and many others, the patient investor will often outperform the overly active one over the long haul just as the patient blue Subaru outpaced my overworked car.
So then, what exactly is the appeal of active investing? The same thing might be asked about the appeal of switching lanes frequently on a congested freeway. Constantly tinkering with one’s portfolio can provide the investor with a sense of control. Further, many of us have a hard time coming to grips with the idea that our brains – or brawn – might not always make a big difference, and we believe the adage, “the harder you work, the luckier you get.” While hard work is certainly important, it is most crucial to work hard at being a disciplined investor that stays the course during volatile times. That can be easier said than done, especially when active investing, like aggressive driving, can be more exciting.
Staying the course does not mean that we put our portfolios on cruise control. It’s still important to be mindful of market volatility, to adjust the portfolio when it materially deviates from its target allocations, and to make other adjustments as life circumstances change. These decisions, though, should be strategic and rational, not reactionary and emotional.
Although 2016 is off to a challenging start, resist the temptation to swerve in and out of lanes too much. History shows us that markets should ultimately work in your favor but success requires discipline and patience.