As part of our ongoing series about behavioral finance, I’d like to address another bias inherent in the human mind that affects our ability to make sound decisions: the Action Bias. This bias describes our tendency to favor action over inaction, often to our benefit.
The Action Bias is definitely a benefit to us, most of the time. With difficult or dangerous situations, most people feel compelled to do something. That’s a perfectly good bias to have in these situations.
However, there are times we feel compelled to act, even if there is no evidence that it will lead to a better outcome than doing nothing would. There is a false belief that doing something will create value. Thinking, observing, analyzing, or simply waiting are all work. Just because no movement of stress is observed doesn’t mean that nothing important is taking place.
How this relates to investing is clear. When faced with short-term market volatility and uncertainty, many investors feel like they must do something. A lot of the time, that means they sell out of the market, not for fundamental reasons but for emotional ones. While it may feel good to have missed a portion of a market drawdown by selling, most investors do not get back into the market at or near the bottom. They compound the mistakes of the Action Bias by allowing their Recency Bias (more on this in coming months) to prevent them from reinvesting.
At RTD, we do our best to fight the Action Bias. A key element of our investment process is that we review our clients’ portfolios daily but act infrequently, only when the allocation is out of balance or if we can harvest losses for the client’s benefit. We do not make quick decisions with a short-term view. Instead, we choose to wait, focus on the long-term and take targeted action that will yield the greatest value.
To paraphrase the lyrics of the song Freewill from one of my favorite bands, Rush, “If you choose not to [act], you still have made a choice”.