Why Dead Investors Outperform the Living
Dead investors don’t read The Wall Street Journal, sell during panics or jump on the bandwagon during manias. They don’t pester their brokers or boast about their portfolio winners. “Fear of missing out” doesn’t trouble them. They cannot lose control and bet the ranch in a weak moment. Yet their accounts in the investing afterlife appear to outperform those of most living souls.
Nonetheless, the moral of the story remains as valid as ever. Much other research reaches the same inescapable conclusions that most investors do better by limiting their impulses toward overtrading.
Fidelity allegedly confirmed this thesis in a wide study supposedly undertaken around 2013 of its inactive accounts. The study might not ever have occurred at all, but found its way into investing mythology as an urban legend. Whether or not it took place, its purported findings remain true as ever: Tinkering with your portfolio can hamper your returns.
A legend is born
The story goes that Fidelity conducted a giant internal performance review of all the accounts the brokerage had been holding from 2003 to 2013. The objective was to identify characteristics shared among them that resulted in the highest returns. The researchers were surprised to discover that those designated “inactive” due to lack of trading appeared to come out ahead.
In fact, there is almost no evidence to prove the review truly happened. While the survey was indeed cited in a Business Insider article in 2014, no original sources appear to corroborate it. Was it a hoax? If we consider the facts cooly, they do not fully add up. How many accounts could Fidelity be holding in the names of deceased customers, and why had the firm not already notified the authorities?
Why the dead take the cake
It has been widely demonstrated how the market rewards inactivity.
University of California professors Brad Barber and Terrance Odean pursued a related line of research, examining the accounts (with names redacted) held 1991 through 1996 at another large discount broker. The academics found that those customers who traded most actively earned an annual return of 11.4% over the period, versus the market’s own bounty of 17.9%. The researchers soon noted that performance differences aligned with the additional frictional expense of trading costs. Those who resisted temptation to yield to impatience and fiddle with their accounts came close to matching the market gains.
Interestingly, women, who tended to trade less frequently, fared better than male counterparts. The ladies, who executed 45% fewer trades, trounced the men by a full percentage point, which was even more salient in taxable accounts.
What explains such a stark discrepancy? Some have suggested the culprit may be misplaced overconfidence, as women are typically more cautious in their investing. In addition, a behavioral trait often exacerbates the damage. We are all vulnerable to confirmation bias, an inclination to seek consistent information that backs up our opinions that have already been formed.
DALBAR, a financial services research firm, releases an annual report on how investor behavior affects returns. The company extrapolates from mutual fund purchase and redemption data to understand the average investor’s experience. DALBAR estimates that the latter have sacrificed 3% to 4% a year, due to unforced efforts, including purchasing expensive funds, and poorly timed buying and selling. Over the long term, the average investor earns 3.6% annually, against the S&P 500’s 9.5%.
Try to play dead
Your best defenses are patience and diversification. Recognize that missing out on just a few stellar days can decimate your returns. JPMorgan has shown that from 1980 to 2014, a whopping two-thirds of all stocks underperformed the Russell 3000 index, meaning only a small cadre were driving returns. Pay heed and diversify!
- Don't try to time the market.
- Ignore volatility and let your portfolio compound over time.
- Avoid the focus on price. Look for sustainable competitive advantage and strong balance sheets.
- Emulate the departed. In particular, don't overthink your investment tactics. They can't overthink either.
Your investment adviser will keep you calm and consistent. As Warren Buffett remarked, “You don’t have to be particularly smart, you just have to be patient.”
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