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The Good and Bad of Doing Nothing

Written by Brian Portnoy, Director of Investment Education

It’s not in our nature to make big changes in our lives when things are going well. Our brains are wired to naturally conserve energy, and without the shadow of stress or danger, we’re likely to stick with whatever’s working. In many ways, there’s nothing wrong with that. Why make the effort to fix what's not broken?

Sticking with what’s working happens to square with some of the most important wisdom on how to grow and remain wealthy: Take a long-run view. Don’t overreact (or react at all) to short-term noise. Be patient. Most of the time, do nothing.

Callout_Article_The Good and Bad of Doing Nothing

Though profound, this wisdom is incomplete. That’s because, in the effort to remain balanced and calm, there is a fine but important line that divides patience from complacency. The rub is that the two are outwardly indistinguishable. They both appear to involve doing nothing.

It’s only in one’s mindset where we can begin to identify a fork in the road. As I see it, one direction is likely associated with a superb long-term outcome. It allows the power of compounding to work its magic without the distraction of the ephemeral. The other, marked by an unfocused mind, is a potential disaster. It’s the lazy conceit that things moving in one direction tend to keep going the same way indefinitely.

At no time in recent memory has this subtle tension between patience and complacency been more acute for investors. This is a theme I have observed in many interactions with investors, including financial advisors. Since the global financial crisis, stocks have soared. Since the market bottomed in March 2009, the S&P 500 Index has annualized at about 19%, around double the historical average. And it has done so with just the occasional bout of volatility. Especially of late, the market is eerily quiet:

  • In 2017 thus far, the S&P 500 Index has experienced the second smallest intra-year market decline (-2.8%) since 1928. Only 1995’s (-2.5%) was smaller. The long-term average is 16.4%
  • Realized market volatility this year (7.1%) is the third lowest over that 90-year period.
  • It’s been more than 300 market days since a 5% correction, history’s sixth longest streak.
  • The market’s long-term Sharpe Ratio (a measure of risk-adjusted return) ranks as history’s best, alongside the late 1990s and early 1950s.

Fantastic results with the appearance of little risk in achieving them is the perfect breeding ground for complacency. When things come easy in any element of our lives, we’re much less likely to stay alert. Taking our eyes off the ball as our portfolios have grown is only human. And, to only reinforce such behavior, many of us appear to be obeying sound investment advice. We buy and hold. We invest for the long run. We do nothing.

I think where we go from here is to build a bridge from complacency to patience. We do so through preparation. Sonja Lyobomirsky and other social psychologists speak of a “prepared mind” in which we deliberately pause and reflect about both our current circumstances and the potential roads forward.

Building a prepared mind doesn’t mean we act; it means that we think about acting under any number of contingencies we can imagine. It can be hard work to do this, but it’s also empowering as it signifies that we are taking control as best as possible. As we engage in this ongoing process, we might find ourselves maintaining the status quo. But that’s okay: Doing nothing deliberately is patience. Resting on our laurels without intention is complacency.

The old saying goes that the best time to fix your roof is when the sun is shining. The market has almost never shone more brightly, so if there’s any moment to get out the ladder and start climbing, this is it. There’s no one (including me) who doesn’t have some patchwork to do.

Here’s some of what I’d be focused on nowadays:

Planning. We frequently equate “money” with “investing,” but it’s a far broader topic than stocks, bonds, and portfolios. I think of our money lives as having four dimensions—earning, spending, saving, and investing. I’d argue that the first three are more important than the fourth, insofar as investing is a non-issue unless the first three have been managed reasonably well.

This is an extremely broad topic where what’s relevant is driven mostly by your life circumstances. Are you addressing the right issues? For example, my wife and I are in our late 40’s and have three children. I’ve long joked that the hardest part of finance is the paperwork and we are in the thick of it—redoing our wills and trusts, assigning beneficiaries, figuring out asset location for investments that are tax (in)efficient, and a host of other things, some of which we should’ve done a long time ago. This is all a time-consuming pain in the you-know-what. Our scanner will be getting a holiday card this year.

These issues are not relevant for our friends in their 20’s and 30’s, nor for our aging parents. Those cohorts have their own agendas. But what’s evergreen for all is a sensible budget and savings plan. Without that, much of everything else can fall apart. It’s both hard work and emotionally difficult to address some of these foundational issues. But the point is that most of us should currently have the mental space to prepare as the market—sometimes a source of acute stress—has been quiet as church mice for a while.

My last thought here is that a trusted financial planner is invaluable in this effort. We don’t know what we don’t know, and those unknowns are often what get us in trouble. Think of this person much less as an expert on markets and investing, and much more as someone who will help you navigate uncertainty.

Assessing and rebalancing. Imagine that you exited the financial crisis in 2009 with a reasonably balanced portfolio, 60% in stocks and 40% in bonds. You then followed sensible buy-and-hold advice and let the portfolio ride without modification. By 2017, your portfolio would be 81% in stocks and 19% in bonds. Yes, bonds have done well, but stocks have done much better. A low maintenance mindset would have produced a much riskier portfolio. And to make matters worse, you’re eight years closer to retirement with exposure to equities that many consider fully-valued, or even overvalued. If you want to rebalance to a more appropriate asset mix, tough decisions await, especially considering the tax consequences of selling out of significantly appreciated accounts.

There are many ways a portfolio can get off track. Of late, the steady climb in riskier assets might have rendered your portfolio more vulnerable to market corrections than you’ve considered.

Others have the opposite problem. I recently spoke to a friend who sold a chunk of his portfolio during the throes of the financial crisis, and has never put the cash back “to work.” It earned about 1% a year while the S&P 500 has roughly quadrupled. He doesn’t feel great about his non-decision, but I know he’s not alone.

A number of financial advisors and other individual investors have told me that they are holding more cash than they think they ought to. For many years, they’ve been waiting for the “dip” or “correction” to occur so that they can invest their cash. Leaving aside the fact that almost no one who has the “I’ll invest on the dip” mentality does so, it’s not clear from the outside looking in whether the issue is regret over gains not made (4 times “x” is 4x!) or that their portfolios are misaligned with their goals.

Some investors are further out on the risk spectrum than they want to be while others have been playing possum for years. Regardless, this is the time for an honest assessment of what one owns and whether it adds up to something that makes sense. (Speaking of excruciating paperwork, just getting all of one’s accounts into a spreadsheet or tool where a holistic view is possible can be a lot of work.) The prepared mind doesn’t necessarily move a lot of things around. But it does become knowledgeable about whether you might need to, and to evaluate whether what you’ve put together is appropriate.

Imagining. I firmly believe that prognostication is useless. Individuals, even experts, are lousy at predicting what will happen in the future. Market seers love to guess future index levels (“Dow 36,000”!?) but nearly all those bets are no better than discarded stubs at the horse track.

However, preparing differs from prognosticating. Preparing imagines reasonable versions of the future and how we could and should behave in them.

One of the most fascinating research efforts in the behavioral sciences explores the impact of the “future self.” This research, which employs sophisticated imaging technologies, has found that the more deliberately we try to “see” what we will look like in the future, the more likely we will make smarter money decisions today. Why? Because that intentional activity forms a deeper emotional bond with oneself; you literally “care” more about the future you than you would otherwise. Thus, the evidence of higher savings rate and better spending behavior among those who engage.

We don’t need fancy MRI technologies to take advantage of this insight. In fact, all we need is pen, paper, and some envelopes. One of the more important findings of research on the future self is that we respond constructively to messages from ourselves. “Commitment letters” can serve as an effective means of steering our future behavior in a different direction than we might act in absence of those letters.

How does this work for investors like you and me? Imagine two versions of the future: one in which the market is up and one in which the market is down. For the sake of simplicity, let’s discard the “up” scenario but not neglect the points about rebalancing made earlier. Let’s focus on the “down” scenario, but now sub-divide it into small (down 5%), medium (down 15%), and big (down 25%) dislocations.

There is no question that almost all of us would act with an increasing sense of fear and urgency at each level down. That’s totally normal. So when one-fourth of our wealth is obliterated and you’re unsure if it will get even worse, how would the current version of you—sitting in a calm market with a reasonable plan and balanced portfolio—advise the future you to behave? There are a lot of possibilities here, but it’s unlikely you’d want you to rip open the envelope and read “Panic! Sell everything now!” To the contrary, there are any number of sensible directions one can take at each stress point. But we have to imagine those during calmer times.

Complacency transforms into patience on the back of preparation. Preparation is easy to acknowledge, hard to articulate, and even harder to execute. But it puts us in charge, in control, which is psychically valuable. So give it shot. Get out that ladder, climb to the roof, and see what needs fixing.

"The Good and Bad of Doing Nothing" — recently published on Forbes.com