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moneysense.ca, 22/02/07
RRSP Tip # 4: Do Not Chase Performance
Money management firms are bombarding us with ads touting their latest best performing mutual fund that returned 30% last year and 20% over the past three and if you are tempted to buy based on the performance, consider the following statistic cited in The Smartest Investment Book You’ll Ever Read:
One telling study involving mutual fund investors in the United States demonstrated that the average hyperactively managed fund investor had an annualized return for the 20-year period from 1985 to 2004 of 3.7%, when the S&P 500 Index returned 13.2%. The investor would have done better with bank certificates of deposit!
The main reason for the underperformance was chasing the latest hot funds. So the next time you see the sexy performance numbers of the fund du jour and you start thinking: “That sure sounds better than the 4% I am getting from my lousy GIC. Maybe I should get in on this fund”. Resist the urge, give your head a shake and remember that chasing performance is the surest route to investment ruin.
moneysense.ca, 22/02/07
Great advice. I guess the other side of that issue is don’t run away from market declines. Once the market drops you’ve already lost the $$ – switching into money market usually means you end up losing on the upside.
In John Mauldin’s book, Just One Thing, the advice is to get into hot things and get out of ‘not’ things – maybe you’re chasing money for a bit, but if you’re with the trend for awhile, that will make up for losses from the peaks.
Or maybe I just interpreted it poorly…
If people didn’t EVER sell their investments, then chasing performance probably wouldn’t do much harm. I think the harm comes from:
1) selling something that you think is doing badly to go chase something else
2) chase something that did well last year, only to sell it after it does poorly the next year (after you bought it)
3) buying some thing that did well (and maybe selling something else) in the previous year while not considering the risk and diversification of your portfolio.
If people just NEVER sold anything and ensured that they was diversified and their risk is where it should be, then they could chase after performance without too much harm. Of course on the other hand, buying something on the upside is pretty stupid so better to buy the things that did poorly in the last year if anything.
Chasing after performance is definitely a major cause of poor performance in a portfolio and ruin, as you say.
Securities that get “chased” tend to be high risk as well which helps explain the disappointment if it tanks later on.
If investors could get excited about a short-term bond fund that smoked the index by .5% last year then they wouldn’t lose much even if they chased that fund.