Key Takeaways
- A deliberate strategy of avoiding leverage, short selling, and complex derivatives serves as a powerful form of active risk management, significantly reducing the probability of catastrophic, portfolio-defining losses.
- Many investment mistakes are self-inflicted “unforced errors” driven by behavioural biases like the need for constant action and overconfidence. Simplification acts as a structural defence against these impulses.
- Historical data suggests a strong negative correlation between portfolio turnover and long-term returns. Strategic inactivity allows the power of compounding to work uninterrupted by excessive costs and poor timing.
- In an environment of elevated geopolitical tension and uncertain growth forecasts, portfolios free from leverage are better positioned not only to preserve capital but to capitalise on dislocations caused by forced selling from more complex strategies.
In modern financial markets, investors are presented with a seemingly infinite arsenal of tools, from complex derivatives to readily available leverage. Yet, the most potent strategy for long-term capital appreciation may not be the mastery of these instruments, but the disciplined refusal to use them. An investment philosophy built on avoiding specific high-risk activities—namely short selling, options trading, and the use of leverage or margin—is not a passive stance. It is an active and rigorous approach to risk management, designed to eliminate the primary sources of unforced errors and permanent capital impairment.
The Anatomy of Unforced Errors in Investing
In portfolio management, as in sport, there are two ways to lose. The first is to be outmanoeuvred by a superior opponent. The second, and far more common, is to commit unforced errors. These are the self-inflicted wounds: acting on impulse, over-complicating a simple thesis, or taking on risks where the reward is poorly skewed. A significant body of research suggests that these errors are often driven by deep-seated behavioural biases. The “action bias” convinces us that we must always be doing something, leading to over-trading and the associated costs. 1
Leverage and derivatives act as powerful amplifiers for these biases. A poorly timed trade on a simple long-only equity position might result in a temporary drawdown; the same trade made with leverage can trigger a margin call, forcing liquidation at the point of maximum pessimism and turning a recoverable dip into a permanent loss. Similarly, short selling introduces an asymmetric risk profile where potential losses are theoretically infinite, a reality that has humbled even the most sophisticated funds during sharp market rallies.
Deconstructing Complexity’s Hidden Costs
Beyond behavioural amplification, complexity introduces structural fragility into a portfolio. Each layer of financial engineering creates new potential points of failure that may remain invisible during periods of market calm.
- Leverage and Margin: The core risk is not the debt itself, but the loss of control. A margin call transfers agency from the investor to the creditor. The decision to sell is no longer a strategic choice but a forced necessity, often contagion across an entire portfolio to meet the call.
- Short Selling: This strategy requires being correct about a company’s failure within a specific timeframe, whilst fighting the market’s inherent upward bias, the company’s survival instincts, and the risk of a “short squeeze”. It is a fundamentally low-probability, high-impact endeavour.
- Options: Trading options successfully requires being correct on direction, magnitude, and timing. The constant headwind of time decay (theta) means that even a correct directional view can result in a loss if the timing is off. It transforms a single bet on a business into a triple bet on market dynamics.
By consciously excluding these instruments, an investor is not limiting opportunity so much as they are installing circuit breakers. They are making a strategic decision to play a game they are more likely to win over the long term: the patient compounding of capital in fundamentally sound enterprises.
The Quantitative Case for Strategic Inactivity
The argument for simplicity is not purely philosophical; it is supported by market data. Numerous studies have demonstrated a durable inverse relationship between portfolio turnover and performance. Hyperactive strategies tend to lag behind their more patient counterparts, a finding that holds across decades of market cycles. This performance drag is attributable to transaction costs, tax inefficiencies, and the simple fact that frequent trading often means crystallising losses and cutting winners short.2
The table below provides an illustrative look at this principle, reflecting findings consistent with industry research on the topic.
| Portfolio Turnover Rate | Typical Impact on Long-Term Annualised Returns |
|---|---|
| High (over 100% annually) | Significant drag from costs and timing errors |
| Moderate (30% to 50% annually) | Reduced, but still notable, impact on returns |
| Low (below 20% annually) | Maximises compounding by minimising friction |
Source: A synthesised representation based on principles from various industry studies on investor behaviour and portfolio costs.
A low-turnover approach forces a focus on what truly matters: the underlying quality of the business and its long-term prospects. It shifts the investor’s role from that of a market timer to that of a business owner, which is a far more forgiving and, ultimately, profitable pursuit.3
Conclusion and a Forward-Looking Hypothesis
Reducing investment mistakes is less about achieving perfection and more about systematically eliminating the avenues for ruin. By avoiding the structural vulnerabilities inherent in leverage, shorting, and complex derivatives, an investor builds a more resilient portfolio by default. In the current global environment, characterised by slowing growth forecasts and persistent geopolitical tensions, this resilience is not merely defensive; it is a source of strategic advantage.4
This leads to a testable hypothesis for the next market cycle: when the next systemic crisis unfolds, portfolios devoid of leverage will not just survive, they will drastically outperform. As forced deleveraging cascades through the financial system, these unleveraged portfolios will possess the one thing that becomes priceless during a panic: liquidity. They will be positioned as buyers of last resort, able to acquire high-quality assets from forced sellers at deeply distressed valuations. Simplicity, in the end, may prove to be the ultimate arbitrage.
References
- Business Insider. (2025, July). *Investing mistakes to avoid when the stock market is at all-time highs*. Retrieved from https://www.businessinsider.com/investing-mistakes-stock-market-highs-fomo-buy-the-dip-risk-2025-7
- Morningstar. (2025). *3 Investing Mistakes to Avoid in 2025*. Retrieved from https://www.morningstar.co.uk/uk/news/258283/3-investing-mistakes-to-avoid-in-2025.aspx
- Schwab. *5 Investing Mistakes You Might Not Know You’re Making*. Retrieved from https://www.schwab.com/learn/story/5-investing-mistakes-you-might-not-know-youre-making
- Investing.com. (2024). *Factbox-Brokerages expect global growth to slow in late 2025 on tariffs, geopolitical tensions*. Retrieved from https://investing.com/news/economy-news/factboxbrokerages-expect-global-growth-to-slow-in-late-2025-on-tariffs-geopolitical-tensions-4122827
