You may have heard the adage that dart-throwing chimps can outperform professional investors when it comes to choosing stocks that will generate return over time.
Some experiments even show the monkeys outperforming the market itself.
How is this possible?
Because as intelligent humans, we think we can predict things, but we are typically wrong more than we are right (it’s the reason I never make big bets).
We can predict the long-term more accurately, but not the short-term.
The media makes it feel like we can predict the short-term. After all, we all want to know what’s going to happen (especially with our money), and predictions make great headlines. But accurately predicting the short-term is nearly impossible.
On the other hand, we can predict longer-term performance to some level of certainty. Stocks typically go up more than bonds over time. Investments that are undervalued are likely to outperform those that are overvalued.
We also know there is a 25% chance a market will be negative in any given year—about one in four years is negative, and three of every four are positive. Investors that are willing to stay put and ride out the down years will see an overall positive return. But most investors think they can predict and outperform the market, so they buy and sell based on short-term news or economic events.
And they are wrong more than they are right.
The result is that monkeys throwing darts at the Wall Street Journal—and sticking with their choices—are more likely to end up in the black in the long-term than the more intelligent investors.
Fidelity did some research that illustrates this point perfectly.
They wanted to better understand their best-performing retail accounts in an effort to isolate behaviors of exceptional investors, so they called them up to interview them. What did these exceptional investors have in common? The commonality was they had either forgotten about the account altogether—or they were dead. Either way, these people weren’t making frequent changes to their investments.
The takeaway? Don’t try to outsmart the market.
Take a rules-based approach to investment management.
Morgan Housel, author of The Psychology of Money, explains:
“Like everything else worthwhile, successful investing demands a price. But its currency is not dollars and cents. It’s volatility, fear, doubt, uncertainty, and regret—all of which are easy to overlook until you’re dealing with them in real time.”
To be successful investors, we must understand there are going to be some bad years, but it is holding on through those tough years that will produce the long-term returns we need. Holding a diversified portfolio also helps to reduce risk and increase long-term returns. Even when the S&P was down 5% from in the span between 2000 to 2010, diversified portfolios had positive returns.
My philosophy is to build a diversified portfolio. Then, use rebalancing as necessary to take the emotion out of selling gains of those asset classes that have become overvalued and buying more of those that are undervalued (or underperformers, on occasion). You can also consider tax loss harvesting when your investments are down to increase your long-term tax-adjusted returns.
None of these decisions should be based on emotions. Plan ahead and adjust your investments according to pre-determined rules that align with your goals.
This is the approach that will make the biggest difference in your portfolio. No monkeys necessary.