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Pick the banjo, not stocks

Created:

22 September 2008

Updated:

23 September 2008

Written by:

Chris Dillow

Last week's events have corroborated one of my pet theories, which is that one of the best things an investor can do is to buy a banjo.

My thinking here is, as usual, very simple. If you'd paid close attention to the market last week, you'd have worried endlessly, at least until Friday. But what if you'd spent the week picking the banjo, and looked only at the market's close on Friday? You'd have saved yourself exposure to Robert Peston's unique diction (his excellent blog is easier on the ear). And you'd have got a different picture of the market. During the week, the All-share lost just 1.7 per cent. Which is an only mildly poor show. Even in normal times, it's the sort of loss that happens one week a month. And it's only the 19th worst week of the last 12 months.

To our banjo-picker, then, last week was a quiet week. To stock-pickers, though, it certainly wasn't. But what did stock-pickers gain to compensate them for four days of worry?

Sure, you might have decided by Thursday that markets had become irrationally pessimistic and so piled in. But equally, you might have gotten carried away with the gloom and gone short, and lost a packet then. Even if you'd managed to to make money during the week, it was only a reward for some stomach-churning dangers.

Our banjo picker had an easier time.

All I'm doing here is reasserting an old fact - that equities look a lot better, the less often you look at them. Let's do some numbers. Let's say shares return 8 per cent a year with standard deviation of 20 per cent - which is the long-term average. Then the probability of losing in a single day is 49 per cent - almost evens. But the chances of losing in a month are 46 per cent; in a year 34 per cent; in two years 28 per cent; and in five years under 15 per cent.

Banjo-pickers, who look only infrequently at the market, therefore get better odds than those who obsess about it.

And this is where a well-known psychological mechanism kicks in. Psychologists call it the Yerkes-Dodson effect. This says that it's possible to be over-motivated, to try too hard; it's why footballers miss crucial penalties and professional golfers simple putts.

Perhaps the same thing afflicts investors. In looking too hard at the market, and looking too much for profitable opportunities, investment performance can actually suffer. Woods and trees, and all that. Maybe the way to make money is to worry less about money.

Hence the case for buying a banjo. Of course, it doesn't have to be a banjo, or even any musical instrument. An allotment or big garden would do, as would knitting, or model railways. Even, God help us, golf. Anything, in fact, that stops you fretting about short-term price moves.