Andrew Lo’s interview with Jack Bogle, In Pursuit of the Perfect Portfolio project
I have one regret related to the writing of our book, In Pursuit of the Perfect Portfolio. We conducted interviews with each of the ten featured investment luminaries, but I didn’t have the opportunity to meet the late Jack Bogle—my coauthor, Andrew Lo, had the pleasure of interviewing him. Bogle was the founder of The Vanguard Group, known for its low-cost index funds, a firm that had over $5 trillion in assets under management at the time of his passing in 2019. Perhaps the best nugget that Bogle shared during the interview with Andrew was: “When you hear news that moves the market and your broker calls up and says, ‘Do something,’ just tell him my rule is ‘Don’t do something, just stand there!’” Not-surprisingly, Bogle referred to investing for the long-term in low-cost index finds as a “winning strategy.”
I immediately thought of Bogle and his mantra when I was listening to a podcast episode of Tim Harford’s entertaining Cautionary Tales. The episode focused on a disastrous British intervention in Afghanistan in the 1840s (intervention in Afghanistan by a foreign country—sounds like déjà vu all over again!). He concluded that in retrospect, rather than intervening, a better course of action would have been “masterly inactivity.”
The term “masterly inactivity” was new to me, but I immediately loved the phrase! It may initially conjure up an image of laziness or procrastination, but it’s much more nuanced than that, as I came to understand. And it’s a versatile concept, applying to a broad number of contexts such as warfare (military, as well as in the boxing ring), parenting, soccer, medicine, and investments. Before I get back to Bogle’s mantra and show how it applies to investing, let’s take a look at some of the other contexts.
Masterly Inactivity and Warfare (and Boxing)
Let’s start with a definition for masterly inactivity—here’s what I found at finedictionary.com: “The position or part of a neutral or a Fabian combatant, carried out with diplomatic skill, so as to preserve a predominant influence without risking anything.” Simply stated and more broadly, masterly inactivity is the art of knowing when not to act. The finedictionary.com definition refers to the successful strategy employed during the Second Punic War (218–201 BCE) by the Roman dictator Quintus Fabius, also known as Fabius Cunctatus or “the Delayer” (there’s an interesting account of it here).
Fabius’s task was to try to defeat one of the greatest military commanders in history, Carthaginian general Hannibal. Hannibal’s army had ravished Italy in a series of consecutive victories. Fabius encamped his troops at Aecae, with Hannibal nearby. When Hannibal learned of their nearby encampment he resolved to terrify the Romans by attacking, but as his army approached and prepared for a great battle, there was no response from Fabius, and so Hannibal’s army retreated back to their camp.
Fabius knew that his army was inferior, and so his strategy was to not risk a battle but rather to bide his time. Fabius reasoned that his army was on home turf and close to supplies. By waiting he could amass a larger army. His strategy was to engage in the occasional skirmish in order to maintain morale, but to avoid a frontal battle until he felt the time was right. Eventually his patience paid off, and Fabius was able to secure a military victory.
One of the greatest boxers of all-time, Muhammad Ali, employed a Fabian strategy in the warfare of the boxing ring against George Foreman, in the famous World Heavyweight Championship on October 30, 1974, the “rumble in the jungle” in Kinshasa, Zaire (now the Democratic Republic of the Congo). Foreman was the reigning champion and his opponents hadn’t lasted more than three rounds before getting knocked out. Ali, the former champion, was the clear underdog. Ali deployed an unusual strategy that became known as rope-a-dope. Instead of meeting Foreman in the center of the ring, Ali leaned back against the ropes, protecting himself and letting the elastic ring ropes absorb much of the force from Foreman’s blows—a great example of masterly inactivity. By the fifth round, Foreman was exhausted, and then in the eighth round, Ali delivered a stunning knockout.
Masterly Inactivity and Parenting
When it comes to parenting, masterly inactivity isn’t about having free time for the parent. Nor is it about a child “doing” masterly inactivity. Rather, it is often referred to as “wise and purposeful letting-alone” by parents, watching while giving children their freedom without intervening. The idea is to allow children to discover life on their own, and to find out the impact of the cause and effect of their actions. Masterly activity is the opposite of helicopter parenting. It involves standing back and letting children explore, while still providing guidance as needed—finding that right balance.
Masterly Inactivity and Soccer
Probably the most exciting play in soccer (or football to our non-North American friends) is the penalty kick, which occurs either when one team commits a serious offence, or when a game is tied after regulation time. The ball is placed 12 yards (11 meters) from the goal. The goalkeeper must remain on the goal-line until the ball is struck by the kicker. Four-fifths of penalty kicks result in a goal, which is significant because on average there are only 2.5 total goals scored in any given game.
There is a clear bias for action: The norm is for a goalkeeper to move to the left or right. Since it takes less than 0.3 seconds for the ball to reach the goal-line, the goalkeeper has to decide on inaction or any action, such as jumping to the left or right, at the same time as the ball is struck. So, what should the goalkeeper do, and what does the typical goalkeeper do? A fascinating study found was that among a sample of elite goalkeepers and penalty kicks, the optimal strategy was actually to stay in the center—masterly inactivity! However, in fact, the goalkeepers deviated from this rational decision-making. Only 6.3 percent of goalkeepers in the sample chose to stay in the center. The authors speculated that the goalkeepers’ intuition for not staying in the center was because jumping left or right was viewed as the norm. If the goalkeeper jumped and was scored on then they were simply unlucky. However, remaining in the center and being scored on would amplify negative feelings.
Masterly Inactivity and Medicine
Imagine being a physician with a vocal patient demanding action, such as a prescription or a test. The doctor may determine that the ideal approach is masterly inactivity—letting the body naturally cope with an ailment while monitoring the patient. And yet according to Dr. Francois Mai writing in the CMAJ, patients and society pay a huge price for the short-sighted approach of ordering unnecessary prescriptions and tests. According to a survey of over 2,000 doctors conducted by the American Medical Association, one-fifth of overall medical care was unnecessary, including 22 percent of prescription medication, 24.9 percent of tests, and 11.1 percent of procedures. Common reasons for overtreatment were fear of malpractice, patient demands, and difficulty of accessing prior medical records. Society would be better off if more doctors practiced masterly inactivity.
Masterly Inactivity and Investing
Now that we’ve seen the challenges—and successes—of masterly inactivity, let’s return to the world of investing. Action bias suggests a tendency for investors to make decisions that will impact on their portfolio, such as reacting to news like a large drop in the stock market by immediately liquidating stocks and moving in to cash. As investors, is there a potential price we pay for ignoring masterly inactivity?
To answer this question, I took a look at daily returns for the broad stock market index, the S&P 500, every day for almost 60 years, back to 1962. I sorted the data from worst to best daily returns and focused on the ten worst days. How would a panicked response of liquidation of stocks—ignoring masterly inactivity—played out? The answer is in the chart below.
This red bars on the chart show the worst 10 days, which occurred in 1987, 1997, 2008, and 2020. The one-day drops ranged from -20 percent to -7 percent. The average mean (median) daily loss—the orange bars—was -9.9 (-8.9) percent. Panic selling would have locked-in these losses. Alternatively, how would masterly inactivity have played-out? The green bars indicate the cumulative returns on the subsequent 10 trading days. In 7 of the 10 cases, the market was up, in one case the market was flat, and on only two cases did the market continue down, and in both those cases the market corrected soon after the 10 trading days. Overall, the average mean (median) short-term rebound—the blue bars—was 2.2 (5.5) percent. So, related to extreme negative events, on average, masterly inactivity seems to have paid off in this sample.
It’s one thing to get out of the market when facing a severe downturn, but it’s another thing to know when to get back in. As was saw with the previous chart, some of the best days’ returns occur shortly after the worst days. So, here’s another thought experiment. What if we were on the sidelines and missed out on some of those bounce-backs. What would be the impact? The next chart tells the story.
The first bar shows the average annualized price changes on the S&P 500 since 1962: 7.61 percent. (Adding in dividends, annual total returns have been around 10 percent.) If we exclude just the 10 best trading days, the average annual return drops around 1.5 percent—and that’s just eliminating 10 days out of 14,809, or 0.07 percent of the sample! Excluding the 30 best days (0.20 percent of days) drops it down to 4.33 percent, and finally excluding the best 50 days (still only 0.34 percent of days) drops the annualized price change to 2.86 percent, or just around one-third of returns since 1962. In other words, you would have given up over 60 percent of the returns.
Of course, masterly inactivity in investments doesn’t mean to never take action. For example, an investor might have a minimum amount of required assets needed to meet certain goals, and therefore a drop below a certain threshold might require risk reduction and liquidation of risky assets like stocks. The point is to actively monitor one’s portfolio and be prepared to take action when necessary, but not in a knee-jerk manner. In other words, have a plan in place, and think before you decide to jump. Often, doing nothing can be a winning strategy. Always remember Bogle’s mantra—it will often pay to “Don’t do something, just stand there!”