Are the best investors dead?
That’s what a Fidelity internal performance review seems to suggest. Fidelity supposedly reviewed the performance of its customers from 2003 to 2013 and found that the best returns were from its customers who were either dead or inactive. These are customers who either died and had their assets frozen, or forgot about their assets.
Whether the research was legitimate or not, the notion that inactive investors outperformed their peers does seem possible.
The market rewards inactivity
The stock market is volatile. The past two years has clearly demonstrated that. Volatility tempts investors to trade frequently in the hope of timing their buys and sells to coincide with peaks and troughs. However, in reality, buying at the lows and selling at near-term peaks is easier said than done.
Investors who trade frequently end up paying more trading fees and may miss out on the best days in the market. The latter is particularly harmful, as missing out on only a handful of the best days in the market has historically resulted in significantly lower returns.
Inactive investors, on the other hand, ride out the short-term volatility of the market whilst staying invested. With the stock market indexes historically going up over the long-term, investors who have simply sat tight and held on to their investments have done extremely well.
Choose wisely and diversify
But not all investments go up over time. A study by JP Morgan found that two-thirds of all stocks underperformed the Russell 3000 index from 1980 to 2014. Moreover, 40% of all stocks had a negative absolute return over the 30-year time frame.
In fact, the bulk of the market’s returns was driven by just a small group of stocks.
What this means is that investors can’t simply buy and hold any stock. We must choose wisely or we’d risk underperforming or even losing money over the long term.
To reduce our risk of losses and increase our chances of holding just one of these high performing investments, we should diversify our portfolio.
This reduces the risk of omission which can be much more costly than the risk of commission.
Learning from the dead
Once we have identified a diversified investment portfolio, we can start to copy the “dead”. By simply ignoring near term price volatility, doing nothing and letting our investments compound over time, investors are likely to outperform their more active peers.
This strategy is, in fact, practised by one of the best-performing investment funds in the world, the Fundsmith Equity Fund. The fund, which is run by Terry Smith, has produced an annualised return of 18.4% since its inception in November 2010. This is far ahead of the MSCI World index which has returned 12.8% in the same time.
Fundsmith follows a simple three-step investment strategy: “1. Buy good companies; 2. Don’t overpay; 3. Do nothing”
But don’t be fooled by the simplicity of Fundsmith’s approach. Buying good companies is one of the pillars of its success. But the third step – – do nothing – has been an important reason behind why Fundsmith’s investments have been allowed to compound.
If Fidelity’s research and Fundsmith’s track record are anything to go by, investors could increase their odds of outperforming more active market participants if they are able to replicate this patient approach.
Note: An earlier version of this article was published at The Good Investors, a personal blog run by our friends.
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Disclosure: Jeremy Chia does not own shares in any of the companies mentioned.