Conventional wisdom is a byproduct of groupthink that presents solutions good enough for the average person while simultaneously not being right for any individual. You follow it at your peril. The more different you are from the person that defined a rule the less you should follow the rule. Each Monday I will challenge the investing norms that just may be holding you back from living the life you want.

Unconventional wisdom: A dangerous time for investors and it isn’t just Trump

“Anxiety is like a rocking chair. It gives you something to do, but it doesn’t get you very far.”

- Jodi Picdoult

On Monday evening I was confronted with a headline from the AFR proclaiming ASX’s $42b wipeout seals worst start to year since COVID crash. That sounds scary. To be clear the “worst” start in 5 years is a 3.90% drop over a quarter.

In 2020 the ASX 200 fell a little more than 35% in one month. On the 16th of March 2020 the ASX 200 fell 9.70%. Comparing what is happening now to 2020 is disingenuous even if it is factually correct.

It is a dangerous time to be an investor. And that isn’t because of Trump. It is a dangerous time to be an investor because when people are anxious and there is volatility they tend to make poor decisions.

Are you feeling anxious? Me too

I’m not trying to minimise the anxiety that investors are going through. I’m anxious. The only world economic order I know seems to be changing – and changing quickly. Change is hard at the best of times. It is harder when what is changing has been good for you. And things have been pretty good for me.

I’ve got my gripes. We all do. But I also admit my career as a consultant and whatever it is I do now wasn’t negatively impacted by globalisation. I’ve been a beneficiary of technological changes and the lowering of trade barriers. I say that without guilt while also acknowledging that many people have been hurt by globalisation.

My wealth has grown by investing in companies that thrived in a world with more cross border trade. I don’t want wholesale change. I have too much at stake. My own anxiety makes it easier to empathise with other people going through the same thing. Yet we need to break this cycle of hysteria for hysteria’s sake. Each one of those headlines is sending signals that you should ignore. The question is – can you?

Advice that nobody needs

Everywhere I look the same advice is being given to investors. And what is that advice? Don’t panic.

The first stage of panicking is to feel anxiety. As I said, I’m there. But the second stage is crucial to panicking. The Oxford Dictionary defines panic as anxiety causing ‘wildly unthinking behaviour’. I will reluctantly join the chorus of voices encouraging you to stop if you are wildly and unthinkingly selling everything. I don’t think anyone reading this article falls into that camp.

Most investors don’t see their actions through this prism. People generally don’t panic. Instead, people rationalise their way into decisions that hurt their long-term interests. We describe investors as capitulating. Yet nobody would describe their own actions as capitulation. And that disconnect between how people see their actions and how they describe the actions of others matters.

An individual investor would say they are selling now before the market falls so they can buy later at lower prices. On the surface this sounds like a good plan. The issue is that it assumes the market falling further is a forgone conclusion. It also assumes you will know when to get back in.

I could also use industry jargon to describe the same reaction from investment professionals. In that case the investor is ‘tactically de-risking their portfolios given the unpredictability of the current environment’. I like this one. It assumes that there is an environment where the future is predictable. Whenever the professional regains clairvoyance they can tactically ‘re-risk’ their portfolio.

Very few investors will mention anxiety. Despite anxiety being a natural reaction to a changing environment we don’t like to admit weakness. Apparently it is better to look tough and act scared than be honest.

That is why almost every investor feels a little smug when hearing the advice not to panic. All of us think we are too smart to panic. In our heads selling is not panicking. It is a rational approach given the current environment.

Why it is a dangerous time to be an investor

Amy Edmonson is a professor of leadership management at Harvard Business School. She has created a spectrum of failure. On this spectrum is a classification of failure which Edmonson calls ‘task challenge.’ Task challenge refers to an activity which is too challenging for reliable, failure-free performance.

Think of an ice skater in the Olympics. The skater is out on the ice alone. They have a routine which they’ve practiced. They know exactly what they need to do. Yet even the best skater in the world will make mistakes. Their routine needs to be challenging to win and that is why the skater will sometimes fail. Often the winner is not perfect - they’ve just made fewer mistakes.

Failures from task challenge go up when you forget about how difficult an activity is. Compliancy and a challenging activity is a recipe for more mistakes. I consider any investment approach other than pure buy and hold passive investing as a challenging activity. You will make mistakes. That is ok. The goal is to minimise them because just like the skater that is how you win.

The task challenge for an investor goes up when emotions are at play. Especially after a long bull market when complacency sets in. For many investors now is one of those times. I can say that confidently based on the data in Morningstar’s annual Mind the Gap study. The study compares the returns of funds and ETFs with the returns of the investors who’ve owned those funds and ETFs. And yes there is a difference.

Investor returns are influenced by the timing of buy and sell decisions. The gap between investment and investor returns is an indication of how poor we are at making decisions. Each poor decision is a point of failure. The cumulative impact was a 1.10% gap between investment returns and investor returns over the previous decade in our latest study. Collectively investors are not up to the challenge in the best of times.

Given this is an annual study the size of the gap will fluctuate each time we run a new set of data. Over time we’ve noticed several patterns. The gap widens if there is more volatility. This is evident when different types of investments have different levels of volatility – say share ETFs and bond ETFs. The investor gap is bigger for share ETFs than bond ETFs. It is also evident when different periods of time have different levels of volatility.

For instance, in 2019 the gap was around 1%. In 2020 with turbulent markets in response to COVID the gap widened to close to 2%.

This makes sense. Volatility is driven by lots of investors making decisions. Some are pulling money out of the market and some are putting money into the market. In 2020 there was a rapid drop followed by an immediate rally. In aggregate each market timing decision by an investor lowers returns. In a year when more decisions are made returns are lowered to a greater degree.

I want to be clear about what happened and what the data is telling us. Given how dramatic and rapid the COVID bear market and rally was it is a good laboratory to investigate poor behaviour.

The market drop occurred over 33 days between February 19th and March 23rd. At some point during that drop many investors decided to sell. This was followed by a furious rally. At some point during the rally many investors decided to buy.

Often these sellers and buyers were the same people. If investors had done nothing and just held on throughout the drop and subsequent rally they would have been 2% better off. Yet they didn’t do this. And despite their best intentions they didn’t buy low and sell high. To do nothing is often the smartest approach.

Now what

I am finishing this article on ‘liberation day’. At the time of writing ASX 200 investors have been liberated from about 2% of their money. Futures in the US are down.

I am on distribution lists from countless ‘market commentators’ and my inbox is flooded with dire predictions. None of this is helping my anxiety.

The cherry on top is that my wife got paid last night. I have a very simple system for investing. I have a minimum amount that I need to reach to invest in individual shares or ETFs. This minimum amount is what I think is appropriate given the cost of brokerage.

The savings from my wife’s pay has put me over the minimum. A few minutes ago I hit buy and purchased an Aussie equity ETF. I did this despite my anxiety. I did this despite the signalling mechanism of falling markets and the handwringing of the chattering class.

I am simply following my plan. My plan is to invest when I’ve hit this minimum. I have an ETF that I’ve been buying because it fits my investment criteria. My plan says to buy more when I have more money. So I bought more. There are many ways I could rationalise not following the plan. Especially today.

Yet to deviate from my plan would imply several things. It would imply that I have a degree of foresight into short-term market movements that I don’t. It would mean that investing in a week or a month or a year would be better than investing today. I have no way of knowing that. And neither does anyone else.

However, I do know some things. I know that over the long-term the market has gone up and survived things far worse than these tariffs. I know that most of the time investors make the wrong decision when they try and time the market. I know that decision making gets worse when markets are volatile and emotions are at play.

I could decide that I’m smarter and better than all these other investors who make poor decisions. While satisfying I’ve found that assuming everyone else is an idiot isn’t an effective strategy to achieve anything in life.

This one contribution to my portfolio is not going to make or break my life. Yet deciding I’m smart enough to consistently and successfully time the market very well could.

Remember that many of the people that come across as calm, cool and collected are anything but. Their compelling sounding rationalisations for selling might be nothing more than justifications for giving into their emotions.

Successful investing is not about denying your emotions. It is about overcoming them.

I would love to hear your thoughts. Email me at mark.lamonica1@morningstar.com

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What i’ve been eating

Sri Lankan food keeps getting more popular. At least for people like me. It has been popular in Sri Lanka for a while where it is commonly known as food. Shani took me to Kasippu in the Sydney CBD for lunch. She ordered a variety of dishes and at the end of the meal she asked me which was my favourite. It was a hard choice – everything was good. I picked the Chicken Koththu which is a roti that has been chopped up and is served with a curry gravy. Shani shook her head and declared it the one dish that tasted the least like what you got in Sri Lanka. Back to the drawing board for me.

Sri Lanka