Michael Mauboussin: "Why Doing Less Can Actually Make You More"

Consuelo Mack WealthTrack - June 24, 2011

CONSUELO MACK: This week on WealthTrack, Financial Thought Leader Michael Mauboussin targets some cherished Wall Street beliefs, including the roles “activity,” “skill,” and “dividends” play in investment success. Legg Mason Capital Management’s Chief Investment Strategist, Michael Mauboussin is next on Consuelo Mack WealthTrack.

Hello and welcome to this edition of WealthTrack. I’m Consuelo Mack. Most of us have been brought up with the belief that to be successful, you have to work hard. And the harder you work, the more successful you ought to be. We are taught such is the case in just about any human endeavor, starting with elementary school and extending through one’s entire professional and even personal life. This week’s Financial Thought Leader guest says not so fast. Yes, hard work and activity pay off in most pursuits but there are some where less is actually more. And wouldn’t you know it, investing is one of those anomalies. We’ll find out why and how to use it to our advantage.

Then there’s the role that skill and luck play in life’s pursuits. It turns out there are certain activities where skill reigns supreme, chess and track for instance. And there are others where luck holds the cards- the lottery and roulette wheel. Where does investing fall on the skill-luck continuum? That’s right, it’s over on the luck side! How do you overcome that?

Be prepared to have some of your most dearly held investment beliefs challenged in the next half hour. The protagonist is Financial Thought Leader, Michael Mauboussin, Chief Investment Strategist at Legg Mason Capital Management, where he writes his thought-provoking “Mauboussin on Strategy” commentary; author of Think Twice: Harnessing the Power of Counterintuition , and More More Than You Know: Finding Financial Wisdom in Unconventional Places (Updated and Expanded) (Columbia Business School Publishing) , named one of the best business books by Business Week. He is also a highly regarded adjunct professor of finance at Columbia Business School. I began by asking Mauboussin to explain why doing more as an investor doesn’t get you better results.

MICHAEL MAUBOUSSIN: Most of us grew up in a world where we were taught hard work leads to more results. And so we want to translate that work ethic into everything we do. It simply doesn’t work in investing. And the main reason is, most of us, what we really want to do is obviously by low and sell high. But what we actually do is buy high and sell low. We tend to want to acquire assets that have done well recently and sell things that have done poorly. So often, more activity leads to poorer ultimate returns in the portfolio.

And I’ll just tell you one little story on this, to make this more concrete. There was a study done by a couple of academics, and they studied over 3,000 endowments, pensions.  You know, these are the big money guys, the really smart guys. And they look at their hire and fire decisions. So which money managers did they hire and which did they fire? And as you’d expect, the ones that they hired are the ones that have done recently really well. They outperformed their benchmarks. They were looking great on paper.  And the ones they fired, they had a bunch of reasons to fire. But the number one reason to fire them was that they had underperformed their benchmarks. Right? Very logical.

But then, they came back and revisited those same money managers two years later, and what they found was the fired managers did better than the hired managers. So that actions, which of course was trying to improve the performance of the portfolio, actually ended up setting them back. And it turns out other academic studies across asset classes, across different investor groups find similar things. So often, sitting tight and doing nothing while difficult, is the best course of action.

CONSUELO MACK: So you just talked about some actions that professionals do. So what are the kind of mistakes and the kind of actions that individuals do and professionals do that can catch us up?

MICHAEL MAUBOUSSIN: Right. And everybody does the same thing. So the main thing individuals do is, they buy things that have done well. If they hear about it or they see about it, they get very excited about it.

CONSUELO MACK: What you call recency bias.

MICHAEL MAUBOUSSIN: Recency bias. So a big example, of course, is who wasn’t buying Internet stocks in the late 1990s, right? They're zooming every day. You want a piece of the action. Who wasn’t getting involved in real estate in the mid 2000s, right? It was very exciting. So people participate pretty much at the wrong time. And when things are very depressed, no one wants to talk about them, or they try to avoid them.

And the statistic, which I know that you guys talk a lot about on the show but it’s always worth reinforcing is, if you look at the returns  from mutual funds and you look at the returns for investors, they're consistently lower. And you say, “Well, how could that be if they're investing mutual?” The answer is, bad timing. They tend to buy high and sell low, and that is very deleterious to long term returns. So the best advice, typically is, find things that are cheap when they're fairly unloved. Buy them and hold them.

CONSUELO MACK: So let me ask you about the buy and hold strategy, because that got a very bad name in the last decade. Because in fact, if you had purchased the S&P 500 Index Fund and you held it for ten years, you lost money.

MICHAEL MAUBOUSSIN: Exactly.

CONSUELO MACK: So it’s not quite that simple.

MICHAEL MAUBOUSSIN: That’s right.

CONSUELO MACK: So I guess the question is, so how do you decide what to buy. And then, how long do you hold it?