Driving in the "Fast" Lane

 Photo by  cemaxx

Photo by cemaxx

During the early 2000’s, I lived in Southern California. It never ceased to amaze that you could drive for hundreds of miles on 4-5 lane freeways in virtually any direction that were always choked with traffic. My amazement turned to grim resignation when my boss told me how great of a job I was doing and that he would like me to take on a bigger responsibility in another part of town, 40 miles away!

The idea of making a daily drive through a highway interchange nicknamed “The Orange Crush” was almost unbearable, in my mind. Soon after taking the job, I joined a gym next to the office which allowed me drive in at 5:00 AM before traffic built up, as well as get in a daily workout. One day in the lunch room, I lamented to a group of my associates how my morning drive wasn’t too bad but that the evening leg was only tolerable if I waited until 7 PM or so to leave the office.

“You need to hire someone that lives down your way to carpool with so that you can drive in the High Occupancy Vehicle (HOV) lane,” said one of my associates. That idea had crossed my mind, but there just weren’t many applicants with my zip code to choose from.

“Buy a Prius,” said another. At that time, hybrid owners could buy a permit that allowed them to drive in the HOV lane. Unfortunately, the permits were limited in number and were very hard to come by.

“Have you tried driving in the slow lane?” asked my third colleague.

“The slow lane?” I replied.

“Yeah, everybody thinks they will go faster if they drive in the left lane, but when everybody drives there, it actually goes slower than the right lane.”

“That’s nuts,” I thought to myself. But that afternoon, I tried it, and it seemed to work!

A little research turned up some validation that there may actually be some science behind this phenomenon. Researchers at Nagoya University showed in a 2008 paper that density of traffic, by itself, leads to traffic jams. Put simply, more cars in a lane leads to more congestion.

Last week, on the 14 hour drive home from the family vacation in Florida, I remembered this tip as seemingly half the state of Texas was jockeying for position in the westbound left lane of I-10 somewhere in Louisiana. Then I realized that there was an investing lesson to be learned here, as well.

Traffic is sort of like the stock market. Everyone seemingly wants to go faster (or make more return) than everyone else. However, even the most skilled drivers can’t overcome the physical limitations of too many cars trying to drive in the same space at the same time. Even though people can see the right lane is less crowded, human nature drives many (pun intended) to stay in the left lane where it is supposed to be faster. Furthermore, those folks that try to anticipate which lane will be faster and switch aggressively back and forth are typically just taking undue risk and creating anxiety for themselves and their passengers.

Remember the opening scene to the 1999 comedy, Office Space?

Looks pretty familiar to what happens when money managers try to outguess the market. There are many skilled drivers in the investment business, in fact, some of the smartest people I have ever met were active money managers. The problem is that many seem to want to drive in the left lane (how many have AAPL as one of their top holdings today?), pass on the right, and continually move back and forth in their attempt to outperform.

Just this week, Morningstar published their Active/Passive Barometer that provides more evidence that this approach to investing underperforms most of the time.

The approach we take at ATX Advisors doesn’t try to predict which lane is going to go faster, we own stocks in both. We do have evidence, however, that some lanes actually DO go faster over the long haul. Academic research shows that if we have enough patience, we will be rewarded in the long run by driving in those lanes.

I don’t know if the route from Lafayette to Austin qualifies as the long run, but the right lane did seem to get us home a little faster last week.