In most areas of life putting in more effort means achieving a better outcome.
The harder and more consistently you exercise, the fitter you get. The more hours you put in studying, the better your grades.
Of course there are a few, very unusual areas where the opposite rule holds. Aldous Huxley’s called this “The Law of Reversed Effort”: the harder you try, the worse you do. Think of quicksand and finger-cuffs, where success is defined by gentle, slow movements.
Knowing that these areas are different, and taking advantage of (rather than fighting) it is one of the smartest, and hardest, things to do.
Saving and Investing are two of those areas.
Imagine two people both trying to save money on a monthly income. Addison has an auto-transfer for $1,000 set up the day after they get paid, and simply lives on the remaining amount in their checking account. Casey aims to save the same $1,000, but only if it’s left over in their checking account at the end of the month. Casey has to exert willpower the entire month to not spend easily available money – much more work. It’s very unlikely Casey will save more than Addison.
In general, the more your savings plan requires a lot of self control, the less successful it will be.
Richard Thaler won the Nobel Prize in Economics (in part) for his work on retirement saving, including the Save More Tomorrow 401(k) plan. In effect, the plan makes it effortless to save. If you make zero active choices, and don’t deviate from the defaults, you’ll be saving into your 401(k) at appropriate at growing levels.
There are now (almost) effortless saving options outside 401(k)s too. Betterment offers the Smart Deposit service, which sweeps excess cash into your investment account. Digit doesn’t ask you how much you want to save: it figures out amounts through the course of the month which it thinks you can afford, and takes them out automatically.
Each of these make it effortless to save, but you do have to choose to use them.
The Law of Reversed Effort holds in investing too. Evidence tends to show that the more effort investors put into improving returns, the worse performance they have.
Barber and Odean found that the average investor underperformed by 1.5% per year which is pretty bad. But when they looked at the most active accounts, they found that those investors underperformed by …. 6.5% per year!
Using a different dataset, different researchers found that 91% of brokerage investors underperformed a passive approach, and underperformed by 8.5% per year. About 1% along in tax and transaction costs, which you only incur when you trade.
This applies to professionally managed strategies. Newfound Research call it the Frustrating Law of Active Management. When a strategy has all the comforting evidence in it’s favor- recent outperformance, size, reputation, recognizability – it has the least likelihood of outperforming in the future. If you want outperformance, and you use historical performance to make your decisions (aka performance chasing), odds are very high you’ll underperform.
There is a story that Fidelity found the best predictor of brokerage performance success to be people who never logged it. While it might be apocryphal (and I’d expect them to disavow any such finding even if it were true), it rings so true it has a life of it’s own.
So, this might sound very strange, but one of the best ways to outperform the average investor, is to not try to outperform the average investor.
Imagine if you found a job that paid you a 25% bonus every day you didn’t come into work. How many days would you come into work?
Respecting the Law of Reversed Effort is one of the smartest things you can do. It will improve your outcomes in areas where it applies, and other areas too! The more effort you don’t spend in saving and investing, the more you can spend in arenas where effort and outcome are correlated.