The RBA palaver?

It’s true that Governor Phillip Lowe erred, badly, in letting Australians believe that rates wouldn’t increase until 2024.

And he and the RBA Board erred in not increasing rates more quickly, and more significantly, once it was likely that inflation was going to be too high.

And yet…

And yet, I think he should likely be reappointed. And that the review of the RBA released today is probably unnecessary (not least because it’s the view of three arbitrary – if eminently qualified – people that may, or may not, be the view of three other, similarly qualified people).

And that’s worth a discussion in itself.

But I want to use that, instead, as a jumping off point to explain how investors often underperform.

See, what’s happening is that plenty of people (including many who are reading this) will have one of two reactions to Phillip Lowe’s recent performance:

1. He screwed up. He should go; or

2. He screwed up, but he’s still the best person for the job.

And your choice matters.

No, not for Phillip Lowe (though hello Treasurer Chalmers if you’re reading this – your choice does matter for Dr Lowe’s continued employment!).

But it matters for your investing.

And I want to demonstrate with some numbers.

According to some relatively recent research, the average US managed fund underperforms the market.

That’s no surprise. The fees alone would all-but guarantee that.

But here’s the kicker. According to the same research, the average US managed fund investor performs worse than the average managed fund!

And if that sounds hard to believe, it’s explained by the fact that many investors sell out of last year’s losers, and invest in last year’s winners, instead.

But… reality being what it is, most funds don’t win two years in a row. The chopping and changing, chasing last year’s performance, costs investors a small fortune.

In other words, making a mistake, or underperforming, usually isn’t fatal.

And, things tend to revert back to average, over time.

Phil Lowe got it wrong, last time.

So, it turns out, did the entire Western world’s central bankers.

Maybe they’re all completely useless.

Or, just maybe, because the future is unknowable, and these circumstances were so unusual, mistakes happen.

If you want to assume Lowe and his cohorts will never be right again, be my guest.

But who do you replace him with? Someone who didn’t learn the lessons of the past couple of years?

Is that really likely to give you a better outcome next time around?

Or is it like managed fund investors who dump last year’s underperformers and buy last year’s winners, hoping they’ve found a path to endless prosperity?

The GOATs of behavioural psychology, Danny Kahnemann and Amos Tversky, knew this.

They gave the example of military aviation trainers. See, there was a prevailing view among trainers of military pilots that if those pilots were given praise after a great landing, performance worsened the next time. If they criticised a poor outcome, performance improved next time.

Which proved…

Nothing.

Other than that performance tends to revert to average. A bad landing was likely an aberration. As was a particularly great landing.

In other words, it had nothing to do with the feedback at all!

Is every central banker in the world suddenly useless? Or are these strange circumstances likely just, well, strange?

How you answer these questions matters for how you approach investing.

If you’re someone who takes feedback from short-term share price movements, you’re going to struggle to be a successful investor.

If you’re someone who takes short term business performance as necessarily indicative of long term performance, you’re going to struggle to be a successful investor.

What matters is long term performance.

Being able to look through short term gyrations – good and bad – and seeing the long term story.

Not chasing last year’s winners. Or selling last year’s losers.

Which isn’t to say last year’s losers will necessarily start winning.

Or that last year’s winners are doomed.

But it’s a reminder that there is, to use another topical statistical concept, far more ‘noise’ than ‘signal’ in most data.

Which, frankly, channels Aesop’s tortoise and hare.

Can it really be possible that, after all of the growing ‘sophistication’ of finance over the past hundred years, it’s really that simple?

It’s more than possible.

It’s very bloody likely, in my view.

Politicians like to find someone else to blame. It’s good for their electoral chances.

We like to find someone to blame, too. It suits our deep seated need for vengeance: It just feels good.

But successful investors, I would argue, focus not on the past, but the future.

And not just the next 6 or 12 months.

But the next 6 or 12 years.

In the RBA context that means not asking ‘Who didn’t make a mistake last year’, but ‘Who is best placed to make the calls next year’.

The investors’ version of that question is trying to identify the companies that have the best chance of long term success, no matter what happened last year.

Feel free to choose the fresh-faced young buck with confidence and bravado, who’s going to learn the hard way.

I’ll take the grizzled general with the battle scars and a determination not to repeat past mistakes, every time.

Fool on!

The post What investors can learn from the RBA’s mistakes appeared first on The Motley Fool Australia.

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Motley Fool contributor Scott Phillips has no position in any of the stocks mentioned. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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