Why doing nothing is an option when it comes to your investments
Why is doing nothing an option?” my client asked the day after Nhlanhla Nene was fired as minister of finance, and the local stock market was crashing. As an executive in a large organisation her instinct was to respond with some action. When I suggested she do nothing about her investments, she was very uncomfortable: “Surely we should do something?”
The answer I gave her has relevance now given the challenges investors are facing.
Financial markets are complex adaptive systems (CASs). In a CAS many independent agents (investors, for example) interact, leading to emergent outcomes (a market crash) that are often difficult to predict simply by looking at the individual interactions. There is also no centralised control mechanism that governs the system’s behaviour.
An easy way to explain a CAS is to look at traffic patterns, especially during peak traffic. The traffic system has a set of explicit and implicit rules. On the way to work in the morning there may be an accident along a route. Every driver is an agent in this system and is thinking and acting independently.
Upon hearing the news of the accident, drivers make decisions on how to react. Some stay on the route hoping it will clear soon; others choose an alternative route; and some unaware of what’s happening carry on as normal.
As each of these agents makes independent decisions, patterns start to emerge. Agents may modify their decisions, leading to other patterns to form. A driver’s best strategy in this scenario cannot be known upfront. Drivers who “do nothing” are also making a decision (informed or not) and contributing to the emerging patterns.
Complexity results from the interrelationship, interaction and interconnectivity of the elements within a system and between a system and its environment. This implies that a decision or action by one part within a system will influence all other related parts but not in any uniform manner.
Massachusetts Institute of Technology student Serena Chan in her paper on CASs states that they “function best when they combine order and chaos in an appropriate measure”. This suggests that financial markets require some investors to do nothing and behave in a more calm and measured manner for the system to function.
Does this mean investors should never do anything about their portfolios given that markets are always somewhere along that continuum between chaos and order?
Certainly not, times such as these are a good test of the robustness of a portfolio. Investors should certainly look at how their portfolios have performed, relative to a suitable benchmark. Now would not be a good time to make changes, but it certainly is to assess your portfolio and note any strategy that should be reviewed later.
Markets are incredibly volatile now because of the Covid-19 fallout globally, and SA’s downgrade to subinvestment grade. It is difficult to implement decisions in such an environment as the delays during implementation could prompt investors to lock in permanent losses. The JSE has lost more than 10% in one trading day in March and gained 6% to 7% on other days. This is not the environment in which to make switches to your portfolio.
On my way to work recently I found myself stuck in a traffic jam due to an accident on William Nicol Drive in Johannesburg. That morning I did not have the energy to think of alternative routes and carried on towards the site of the accident. Fortunately, the traffic department had arrived on the scene and started directing cars. I got to work a lot faster.
Global authorities are on the scene of this economic crash and are affecting patterns in the market. Investors may, as a result, do well if they simply stay the course for now.