It seems I can’t turn on the TV these days without Robert Peston whinging on about the European Debt Crisis and the possible collapse of the Euro. The same is also true of radio and the printed press. So what is really going on and what should we do?
Lets be honest, Greece is effectively bankrupt and Italy, Spain and probably others, aren’t far behind. There was panic in the markets last week when one of the main ratings agencies (S&P) mistakenly published a downgraded rating of France’s credit worthiness on its website. So clearly there is a problem and clearly markets are worried about the outcome.
The implication being extrapolated from all of this is that investors should do something, or as financial folks might say, take proactive measures. I can almost hear the financial pundits scream, “Whatever you are doing now obviously isn’t working so change while you still can. Protect what is left of your investments before the Eurozone implodes……….”
Hang on a minute. Lets look at this logically. All the research available shows that investors consistently harm themselves by trading too much. Invariably, investors sell investments after a loss and run away to lick their wounds just before a spectacular recovery. Equally, investors often pile into markets at the height of a bubble, usually just before the bubble bursts and it all comes crashing down. Study after study shows that doing nothing, or rather being disciplined and sticking to the long term plan, invariably leads to better outcomes than taking action in the heat of the moment in the middle of a “crisis”. Bear in mind markets are irrational and driven by human emotions.
At the Institute of Financial Planning (IFP) Scottish Conference yesterday, I heard Professor Steve Thomas of CASS Business School speak about behavioural biases that affect investor decisions (usually for the worse). Then, when I went home my son and I watched the Top Gear presenter James May’s program Man Lab in which he tried to learn how to take the perfect penalty kick. These two events got me thinking about a study carried out a few years ago by some Israeli psychologists which examined the actions of top goal keepers trying to save penalty kicks. The study, “Action Bias among Elite Soccer Goal Keepers: The Case of Penalty Kicks”, was originally published in the Journal of Economic Psychology. If you really want to trudge through the detail you can click here and download a copy.
I will summarise the findings of the article for those you with better things to do with your time. Basically, goal keepers almost always dive left or right to save a penalty kick, even though they would have a far higher probability of saving it if they stayed in the center and didn’t dive at all. The psychologists hypothesised that the reason goal keepers dive, even though they know they shouldn’t, is that it feels worse to let in the goal having done nothing than having at least “tried” even though the end result was still the same.
The study then went on to show the same psychology is at work in investment markets, business management and Government (particularly with regards to economic policy). In all cases action is often taken to avoid potential critiscism (or personal feelings of remorse) over not trying rather than because it was the right thing to do.
So what should investors do at the moment – stand still in the middle of the goal. Don’t make any knee jerk reactions, just stick to the plan. We have been in situations like this before and will be in situations like this again. History shows us time and time again that a well diversified portfolio will produce respectable results in the end.