Investing is a Passive Pursuit

Investment Process: Common Sense and Knowledge of Business is Important

“The stock market is designed to transfer money from the active to the patient.”
– Warren Buffett

Efforts to time the market, select mispriced stocks or pursuing “hot” investment managers and mutual fund managers are likely to do more harm than good.

Investing is one of those rare human endeavors where effort doesn’t necessarily pay off. Taking a hiatus on trading one’s account may actually be helpful to a portfolio’s returns.

I remember reading about a study by Fidelity had concluded that the customer investing accounts that had performed the best were the ones held by people who had forgotten they even had Fidelity accounts, and so did no trading from their accounts.

Similarly, when families fight extended court battles over many years for rights over inherited assets, the investment accounts in question cannot be touched for 10 or 20 years. Such feuding families found that over an extended period of inactivity, their investments performed the best.

Daniel Solin of DailyFinance explores the ramifications of these stories:

These investors took no advice from a “market-beating” broker or adviser. Considered no financial news. Made no effort to time the market. Made no additions to or subtractions from their portfolios. They engaged in no analysis of any kind. And yet, it worked. Could this be the key to investing success?

Here’s sage advice from Warren Buffett:

  • In Berkshire Hathaway’s 1990 Chairman’s letter and annual report, Warren Buffett wrote, “Lethargy bordering on sloth remains the cornerstone of our investment style: This year we neither bought nor sold a share of five of our six major holdings.”
  • In Berkshire Hathaway’s 1996 Chairman’s letter and annual report, Warren Buffett wrote, “Inactivity strikes us as intelligent behavior. Neither we nor most business managers would dream of feverishly trading highly-profitable subsidiaries because a small move in the Federal Reserve’s discount rate was predicted or because some Wall Street pundit had reversed his views on the market. Why, then, should we behave differently with our minority positions in wonderful businesses? The art of investing in public companies successfully is little different from the art of successfully acquiring subsidiaries. In each case you simply want to acquire, at a sensible price, a business with excellent economics and able, honest management. Thereafter, you need only monitor whether these qualities are being preserved.”

However, long periods of neglect can only be taken so far before it gets dangerous. Unless you periodically rebalance your portfolio or sell stocks where your original investment philosophy no longer holds or where the fundamentals have deteriorated, you will either be taking too much or too little risk. Over time, this can have serious consequences.

A rational investor must take the path of simplicity and relative moderation via the use of index funds, ETFs, and other passive investments rather than fooling themselves into believing that they can consistently “beat the market.”

The best returns originate from those investors who wait for the best opportunity to show itself before making a commitment. Those who chase the current hot stocks usually end up losing more than they gain, over the long term.

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