Source: Minimalist Investment

The following is the full translation of Chapter 17, 'Beware of Action Man,' in the book:

What do goalkeepers facing penalty kicks and investors have in common? The answer is that both tend to take action as they feel it's necessary to do something. However, waiting is also a choice, and sometimes holding cash is totally acceptable. But for many fund managers, this remains to be a curse. Perhaps they ought to remember Paul Samuelson's advice: investing should be boring. It shouldn't be exciting. Investing should be more like watching paint dry or watching grass grow.

Imagine you are a goalkeeper facing a penalty. You have no idea which direction the shooter will take. You must make an effective decision at the same time the shooter does. Should you dive to the left, to the right, or stay in the center of the goal line?

Most professional goalkeepers tend to dive left or right. Surprisingly, in 94% of cases, selecting a direction is the preferred action. However, this is not the best course of action. If you look at the probability of penalty kicks being saved, you will find that staying in the center of the goal line is a wiser choice (assuming the shooter's behavior does not change). Goalkeepers show obvious action preference.

Evidence from experimental markets shows that investors also exhibit action preferences. For example, in an artificial asset market where the basic value is easy to calculate and resell shares are prohibited, there should be no trades that are higher than the basic value. However, repeated experiments have shown that many trades much higher than the basic value occur in the market. This makes no sense. Since reselling is prohibited, people cannot expect to trade with a larger fool. These trades are very boring and demonstrate that action preferences do exist.

Warren Buffett has compared investing to an exciting baseball game with no umpire calling balls and strikes. Investors can just stand at home plate and watch the pitches go by, waiting for their sweet spot to come, and then hit it out of the park. However, as Aswath Damodaran described, 'Most institutional investors, feeling compelled to stay in the game, whack at every pitch.'

The legendary Bob Kirby once suggested that we adopt the 'coffee can portfolio' approach, where investors buy stocks and then ignore them--he described this idea as 'passive-aggressive.' However, Kirby also pointed out that this method is unlikely to be widely adopted because it may fundamentally alter the ecology of our industry and significantly reduce the quality of life of asset management practitioners. It sounds like a good idea.

Some people may not know that many years ago when I was a child, 'Action Man' was a popular children's version of the soldier statue. He was a symbol of masculinity. But one day, I came home from school and found that my sister had kidnapped my 'Action Man' and forced him to play happy families with her Cindy dolls. This delayed its influence on me. But leaving aside my childhood issues, would you want an 'action man' to manage your investment portfolio?

1. As an 'action man' goalkeeper

Although not the star of the team, top goalkeepers are 'action men' in penalty shootouts. A recent study by Bari-Eli et al. (2007) revealed some interesting patterns when trying to catch penalty kicks. In football (a sport I'm basically clueless about), when a penalty is awarded, the ball is placed 11 meters away from the goal line, and it's a simple battle between the goalkeeper and the shooter. The goalkeeper cannot leave the goal line before the shot is taken.

Given that in an average football match with 2.5 goals, one penalty (with an 80% chance of success) can have a massive impact on the outcome of the game. Therefore, unlike many psychological experiments, there is a lot at stake.

The author analyzed 311 such penalty shots in the world's top leagues and championships. A group of three independent referees were used to analyze the direction of the shot and the goalkeeper's movement direction. To avoid confusion, all directions (left or right) are broadcast from the goalkeeper's perspective.

Roughly speaking, the ball kicked out was evenly distributed, with roughly one-third of the balls aimed at the left, center, and right of the goal. However, goalkeepers showed a clear action preference, either diving to the left or right (at a 94% probability) and almost never choosing to stay in the center of the goal line.

However, to evaluate the 'best' action, we need to know the success rates from the combination of shots and saves. Table 17.2 shows this. The best strategy is obviously to stay in the center of the goal, where he saved 60% of the shots aimed at the center of the goal, far higher than his success rates when diving left or right. However, the goalkeeper only stays in the center of the goal 6.3% of the time! The behavioral bias shown by goalkeepers is clearly not the best behavioral pattern.

The reason for this action preference seems to be that it is seen as a norm. Goalkeepers at least have a sense of effort when diving to the left or right, while standing in the middle and watching a ball fall on their left or right would feel worse. Bari-Eli et al. confirmed this through a survey of top goalkeepers.

2. Investors and action preference

In order to introduce the evidence of investor action preferences to you, I must first introduce the experimental field of economics, especially experimental asset markets.

These are great inventions that study people's behavior in financial market environments - without any complex factors. These markets are very simple - they only include one asset and cash. The asset is a stock that pays dividends once per period. The dividend paid depends on the state of the market (four possible states). The weight of each state is equal (that is, the probability of each state occurring in any given time period is 25%).

Figure 17.2 shows a typical result of one asset market. The asset was initially severely undervalued, then rose significantly above fair value, and finally fell back to basic value in the last few periods. This is just a simple bubble formation and burst. What does this have to do with behavioral preferences? Figure 17.2 is a particularly interesting version of an experimental asset market run by Lei, Noussair, and Plott (2001).

In this special version of the game, once you buy a stock, you are prohibited from reselling it. This excludes the possibility of larger foolish theories driving the bubble. That is to say, because you cannot resell stocks, it is not necessary to buy them at a price higher than fair value. You cannot sell them to others for higher returns. In fact, participants only trade out of boredom! Therefore, investors do tend to take action.

III. Buffett on Key Balls

The madness of this action bias is directly contrasted with Warren Buffett's advice. He likes to compare investing to baseball, which is very similar except for the fact that there are no umpires calling balls and strikes in investing. Therefore, investors can stand in front of home plate and simply watch the ball pass by without being forced to swing at it. However, as Seth Klarman pointed out in his book Margin of Safety, "Most institutional money managers... have a feeling of being forced to invest all the time. Their behavior is like the umpire calling balls and strikes, mainly strikes, forcing them to swing at almost every pitch, giving up the choice of hitting frequency."

IV. The preference for action is particularly evident after poor performance

The last aspect of action bias deserves special attention - it often intensifies after loss (in a period of poor performance in our field of expertise). Zeelenberg et al. (2002) used a loss framework to illustrate the transition from inaction tendency to action tendency.

Zeelenberg et al. asked people to consider the following question: Stinran and Strelaster are soccer coaches. Stinran is the coach of the Blue and Black Legion, and Strelaster is the coach of E.D.O. Both of them lost the game 4-0 in the last game. This Sunday, Stinran decided to do something: send three new players on the field. Strelaster decided not to change his team.

Both teams lost the game by a score of 3-0 this time. Which coach, Stinran or Strelaster, regrets more?

Participants saw this statement in one of three forms. Some received the information as described above (that is, on the premise of previous losses), while others only received the latter half of the statement (that is, without previous information). The last group saw a version where both coaches won last week and lost this week.

If the team won last week, then 90% of respondents believed that a coach who made a change would feel more regret after his team lost this week (this is a well-known tendency toward inaction or inaction). However, look at what happens when both weeks are lost as above. Now, nearly 70% of respondents believe that coaches who do nothing will feel more regret - thus, the impulse toward active preference is exceptionally strong when dealing with losses.

V. Conclusion

Psychology and empirical evidence seem to strongly suggest that investors tend to take action. After all, they are engaged in "active" management, but perhaps they should remember that waiting is also a choice. As Paul Samuelson once said, investing should be boring. It should not be exciting. Investing should be more like watching paint dry or grass grow. If you want excitement, just take $800 to Las Vegas, even though it is not easy to get rich at Las Vegas, Churchill Downs or the local Merrill Lynch office.

The legendary figure Bob Kirby wrote"The Coffee Can Portfolio" (The Coffee Can Portfolio, Kirby, 1984), in which the investor must buy stocks and then ignore them - he describes the idea as passive aggressive behavior.

Kirby said: I doubt that this concept is likely to be popular among investment managers, because if it were widely adopted, it could fundamentally change the ecology of our industry and possibly drastically reduce the quality of life for asset management industry practitioners.

The concept of the coffee can portfolio can be traced back to the old west, where people put their precious properties in coffee cans and then put them under their mattresses. Coffee does not involve trading costs, management costs or any other costs. The success of the project depends entirely on wisdom and foresight, used to choose objects to put in the coffee can at the start...

What kind of results will excellent fund managers produce without these activities? The answer lies in another question. Are we traders or true investors? Most excellent fund managers may be investors at heart. But Cortolone, news services, and computers that produce a large number of investment results every day make their behavior resemble traders. They start with reliable research, look for attractive companies in bullish industries in the long term. Then, they trade these stocks two or three times a year based on monthly news events and various forms and sizes of rumors.

Editor / jayden