Inaction is the best action in volatile stock markets

A research in the US found that equity markets and investments after 2009 made great returns but, many investors did not. It is not because many investors did not participate in the markets, but the research covered only those who were investing in the market during that period. The reason was that many could not hold on to the continuous rise in the market, which is now the second longest in its history and is about 108 straight months.

This is the irony many investors face - why is my portfolio not performing well when the markets have done better? Of course, part of it is to do with the portfolio construct or the nature of the market run-up, but most of the times it is the investors’ folly of making changes in their investments that turns detrimental for the lack of growth.

Research points that it is not intelligence that makes money in the market but the behavior. The investor’s psyche is what makes or breaks, and it is imbibed in us as part of our nature. Much before our evolution, as sapiens we were more nomadic and hunter-gatherers and relied mostly on instincts. Almost all the instincts and the senses led to action. For instance, if we hear a sound in the dark, the first instinct is to raise alarm and search for a weapon and it was the routine exercise back then. Despite creating enough security around ourselves, much of the human tendencies remained in us and thus the behavior.

So, we like to act and remain thick in action rather than sit and watch. We feel boredom if there is no action. This always leads us to act or do something especially when we see the markets acting in either ways. Unfortunately, the greatest action in investing is inaction. If we were to see the greatest market collapse or rallies in the stock market history particularly on a single session or a day, the spike or trough is huge, then we are left baffled. But, if we see in a different perspective of looking these same spikes or troughs in a larger period of 20, 30 or 50 years they just remain a small blip in the entire journey.

I know people always point out to the ‘lost’ decade of the Japanese stock markets, where even after almost three decades, the highs earlier reached aren’t yet breached. This is again to do with our behavior where we tend to give utmost importance to the least probable event than the most probable one.

For instance, the probability of a person dying in a plane are fewer than a pedestrian walking on the sidewalk. However, we pray for a safer flight while we act carefree on a footpath. In a volatile market, if an advisor or a fund manager doesn’t act, we consider their inaction to being thoughtless or even reckless. On the contrary, many a times, not to act is the best action at that point of time. If an investor could control or curb this urge to act, always, would do a lot of good to him/her and also to their portfolios.

Therefore, an investment objective is critical and designing one based on proper risk profiling along with a strategic asset allocation with a tactical plan to counter during larger changes in the markets would help. This would also help ease the nerves, bring calm to not just the investor but pull down the volatility or beta in one’s portfolio. As they say, it’s not the news that triggers the market but the reaction to the news. If one is clear about their objectives for being in the market and the rationale behind picking up an instrument along with the time horizon then it makes for a lot of good for the investor.

By: K Naresh Kumar
(The author is co-founder at Wealocity, a wealth management firm and could be reached at knk@wealocity.com)