The Secret to Investing Success: A Good Case of Amnesia

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I am fascinated by an anecdote related recently by James O'Shaughnessy of O'Shaughnessy Asset Management. An employee who recently joined his firm told him that Fidelity had studied which customer investing accounts performed the best: They were the ones held by people who had forgotten they even had Fidelity accounts and so did no buying or selling from them.

When O'Shaughnessy told that tale on Bloomberg Radio to Barry Ritholtz of Ritholtz Wealth Management, Ritholtz responded that he'd noticed something similar with families fighting over inherited assets. Because of extended court battles, in some cases, the accounts couldn't be touched for 10 or 20 years: No buying new investments or selling old ones. Those families subsequently found that the period of inactivity was the time when their investments performed best.

Think about the ramifications of these stories. These investors took no advice from a "market-beating" broker or adviser. Considered no financial news. Made no effort to time the market. Made no additions to or subtractions from their portfolios. They engaged in no analysis of any kind. And yet, it worked. Could this be the key to investing success?

Listen to Warren Buffett

No less an authority than Warren Buffett thinks it is. In his 1996 chairman's letter to shareholders, he stated: "inactivity strikes us as intelligent behavior." In a similar vein, he observed in his 1990 letter that "Lethargy bordering on sloth remains the cornerstone of our investment style."

A number of studies support a strategy based on inactivity. The one I found most compelling analyzed 80,000 yearly observations of institutional investment assets, accounts and returns from 1984 through 2007. Keep in mind that these are extremely sophisticated investors, managing trillions of dollars in assets, with huge budgets. They can afford to hire the best investment "pros" in the business.

As you can imagine, there was a lot of buying and selling over this period. But the study concluded that portfolios of products to which money was allocated underperformed compared to the products from which assets were withdrawn. Translation: They bought losers and sold winners. The authors of the study estimated these decisions cost the plans more than $170 billion in value.

A blog post by the senior economist at the Federal Reserve Bank of St. Louis found that the average stock mutual fund investor tends to buy when past returns are high and sell otherwise. He calls this activity "return-chasing behavior." He found that, when compared to simply buying and holding, return-chasing behavior had a "significant impact" on returns -- and an expensive one. From 2000 through 2012, a simple buy-and-hold strategy earned an average annual return of 5.6 percent, compared with only 3.6 percent for return-chasing investors.

Remember to Rebalance for Risk

While the benefits of totally neglecting your portfolio seem to have surprising merit, there is a clear downside to this strategy. Unless you periodically rebalance your portfolio by selling asset classes that have increased in value and buying those that have decreased, you will either be taking too much or too little risk. Over time, this can have serious consequences.

The real takeaway from the data extolling the virtues of neglect, or even abandonment, of your portfolio is that efforts to time the market, select mispriced stocks or identify the next "hot" mutual fund manager are likely to do more harm than good.

If you are tempted to engage in this behavior, maybe you should just forget about it!

Daniel Solin is the director of investor advocacy for the BAM Alliance and a wealth adviser with Buckingham. He is a New York Times best-selling author of the Smartest series of books. His latest book is "The Smartest Sales Book You'll Ever Read."

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The Secret to Investing Success: A Good Case of Amnesia
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