Sovereign Wealth Funds
Investment Tip: Doing Less
When investment decision-making goes wrong.
April 5, 2011
This morning some smart folks directed me to a fun little research report by Michael Mauboussin of Legg Mason that really resonated. The report’s entitled “Why Doing Less Can Leave You With More.” That sounds nice, right? Whatever Mauboussin is selling, I’m buying.
All kidding aside, the report highlights some behavioral problems with investment decision-making that do not add value to portfolios. Basically, the report makes the case for long-term investing. And it does it in a fun way. For example, the report kicks off with a nice anecdote:
“Robert Kirby, one of the founders of Capital Guardian Trust, told a story of a couple he worked with as an investment counselor for about a decade through the mid-1950s. Since wealth preservation was the primary objective of the client, Kirby followed his firm’s guidelines and bought and sold investments to make sure that the portfolio was sensible and well-positioned. Kirby worked primarily with the husband on a portfolio in the wife’s name.
After the husband died suddenly, the wife called to say that she had inherited his estate and was adding his investment portfolio to hers. Kirby reviewed the man’s portfolio and was amused and shocked. He was amused to see that the man had piggybacked the firm’s buy recommendations to his wife. The man purchased about $5,000 of each stock, tossed the certificates into a safe deposit box, and simply ignored the investments. Kirby called it the “coffee can portfolio” because it reminded him of a time when it was common for someone to place his valuables in a coffee can and stick it under his mattress. Since it incurred no transaction or administrative costs, the can’s value hinged solely on what the owner placed in it.
Kirby was shocked when he saw the value of the man’s portfolio, which greatly exceeded that of his wife’s. It was an odd mix, to be sure. There were a number of holdings that had sunk to $2,000, several large positions that exceeded $100,000, and one stock with a value in excess of $800,000. That jumbo position was the result of a small commitment to a company called Haloid Photographic, which later changed its name to Xerox.
The lesson that Kirby took from the episode was not that an investor should buy stocks hoping to find the next Haloid (or Google or Apple). Rather, it was that a portfolio created by acting on only half of the firm’s recommendations and with negligible costs handily outperformed the portfolio to which Kirby fully attended. Buying undervalued stocks and doing nothing did better than attempting to navigate the market’s ups and downs. Warren Buffett expressed a similar point when he said, “Lethargy bordering on sloth remains the cornerstone of our investment style.”
Most of us are taught from a young age that effort leads to results. But if you take effort to mean activity, the lesson doesn’t apply for long-term investors. The message here is simple: investors often make changes to their portfolios—with the best of intentions—that do not add value. This is as true for sophisticated institutions as it is for the unsophisticated individual. Doing less can leave you with more.”
In case you’re a visual learner, here’s the problem with short termism (click graph to enlarge):
This post originally appeared on the Oxford SWF Project website.