Why the smartest investors often do nothing

ETFs can help investors avoid costly behavioural mistakes, from overconfidence to panic selling. Their real value may lie as much in what they stop us doing as what they invest in.

One of the most frequently used phrases in our house when my two boys were younger was, "Just stop touching it".

Don't pull it apart. Don't press the button again. Whatever is happening right now, there is a reasonable chance that your involvement will make it worse.

As it turns out, this isn't terrible investment advice either.

There is something deeply irritating about investing. The smartest thing to do is often nothing.

Humans aren't particularly good at nothing. We like activity. We especially like decisions that make us feel clever. Investing gives us an almost endless supply of opportunities to scratch that itch.

Should I buy? Should I sell? Is the market too high? Should I take the profit? A friend made 40% on something I'd never heard of until Tuesday, should I get in too?

Every one of these feels like an opportunity to make money. They're also opportunities to make a mistake.

Which is why one of the most interesting things about exchange traded funds, or ETFs, isn't necessarily what they invest in. It's what they can stop us doing.

A broad ETF is wonderfully boring. Rather than trying to identify which individual companies will outperform, you can buy a basket containing tens, hundreds or even thousands of investments.

Why investors are their own worst enemy

In behavioural terms, that's important because humans have an impressive track record of undermining ourselves when making financial decisions.

Take overconfidence. Most of us believe we're better-than-average drivers. We tend to think we're pretty good judges of character too.

Give us access to a trading account, a few finance podcasts and six months of rising markets, and suddenly Warren Buffett had better watch his back.

The problem is that confidence and competence are not the same thing. Picking individual investments also gives our brains something they love: a story.

We can explain why a particular company is going to take off. We've seen the new product. We've read about the CEO. Everyone is talking about AI, lithium or whatever else is currently attracting attention.

Once we've constructed the story, confirmation bias gets to work finding reasons we're right.

The cost of doing something

Then there's recency bias.

Whatever has happened lately suddenly feels more likely to keep happening.

A sector that's delivered spectacular returns starts looking like an obvious investment, conveniently after it has delivered spectacular returns.

When prices fall, another quirk enters the room: loss aversion.

Losing $1000 generally hurts considerably more than gaining $1000 feels good. So when markets become volatile, our instinct isn't always to calmly revisit our long-term strategy. Sometimes it's simply to make the uncomfortable feeling stop.

We sell.

Then the market recovers and another uncomfortable feeling arrives: the fear that we're missing out.

So we buy again.

This isn't because people are stupid. It's because our brains weren't designed for financial markets. They were designed to respond to threats and learn quickly from recent experience.

Very useful when something is rustling in the bushes. Less useful when your portfolio has fallen 8% and you've checked it four times before breakfast.

Perhaps the most underappreciated problem is action bias. When something important is happening, we feel we should do something about it.

It's something I've watched with my boys countless times.

If something won't fit, push harder. If a button doesn't work, press it another six times. If your brother is annoying you, apparently the obvious solution is to annoy him back.

Adults are more sophisticated, of course.

Markets fall, so we sell. Something shoots up, so we buy it. Nothing much is happening, so we fiddle with the portfolio just to make sure we're still participating.

Doing something gives us the comforting sensation that we're in control. But activity and progress aren't the same thing.

This is where broad ETFs become psychologically interesting. Used as part of an appropriate long-term strategy, they reduce the number of predictions you need to make.

You don't necessarily need to decide which bank will outperform, which mining company has the better prospects, or whether this month's hot stock still has room to run.

You're effectively admitting something humans find surprisingly difficult to admit: I don't know.

And that can be an incredibly powerful financial position.

The hardest investing skill

Of course, we've even managed to complicate ETFs. There are now funds covering increasingly narrow sectors, industries and themes.

Give humans a simple investment tool and enough choices, and we'll eventually find a way to start tinkering with it, which rather misses the point.

We often imagine wealth is built through brilliant financial decisions. Spotting the winner, selling at exactly the right moment or seeing something everyone else missed.

Occasionally this is true.

For most of us, though, there may be a more reliable strategy.

Build a sensible system. Automate what you can. Diversify appropriately. Give your investments time.

Then create fewer opportunities for your emotional, overconfident brain to interfere.

Raising boys has taught me that one of life's great lessons is knowing the difference between something that requires your attention and something that merely attracts it.

Sometimes the smartest thing you can do is to just stop touching it.

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