The dangers of chasing investment returns

May 2, 2019

It can be a hard temptation to avoid; you sit there and watch while other investments outperform your own, and you begin to wonder… why don’t I just invest my money there instead?

It can be a hard temptation to avoid; you sit there and watch while other investments outperform your own, and you begin to wonder… why don’t I just invest my money there instead?

The reality, though, is that chasing investment returns is a dangerous strategy that can wind up backfiring on you over the long term.

A common investing scenario

Meet Bill and Anna, a typical young couple who have invested $1,000 in shares.

During a particularly tough investing year for shares, the market happens to be down 30%.

Bill notices that fixed-income investments like bonds actually gained 5% over the year. He and Anna agree to sell their shares and buy bonds instead.

Bill and Anna are thrilled to see that, the following year, their bond investments net them a 7% return.

After dropping to $700, their investment is now worth $749.

There’s just one little problem. During the same period, shares rebounded and returned 37%.

If they had just left their money where it was, they would have $959 instead of the $749 they ended up with as a result of jumping ship.

Think of it like this: have you ever driven on a multi-lane highway, only to find yourself stopped dead in a lane while the others move forward around you?

Then, when you finally get fed up and switch lanes, your new lane stops while your old lane begins moving forward again.

It’s infuriating, and it’s what happens when you chase investment returns.

Now, let’s look at a more scientific example that illustrates the true risk of chasing performance instead of sticking to your decided-upon investing strategy.

Vanguard study

Vanguard is a US fund management company, and one of the largest in the world.

In an effort to quantify the true damage done to a portfolio by chasing investment performance instead of simply buying and holding, they commissioned a decade-long study that spanned a range of investments, from riskier small-cap funds to more reliable large-cap options.

During this study, they measured the results achieved by buying and holding an average cross-section of shares, compared to purchasing only top-performing investments from the past three years, and selling any investment that underperformed three years in a row.

What the company found was that, across every single type of investment category, buying and holding yielded a higher return than chasing investment performance, often by 2-3%.

Over an extended period of time, that variance can have a massive impact on the size of a family’s retirement nest egg.

You can view the full results of Vanguard’s study here.

The 2007-8 Global Financial Crisis

While the Bill and Anna example mentioned above is fictitious, the truth is that many families followed nearly the exact same path during the Global Financial Crisis of 2007-8.

They panicked when the market dropped, sold their investments in favour of safer ones, and then subsequently missed out when the markets inevitably rebounded.

While it can be difficult to manage when you’re watching your own investments drop and everyone around you is scrambling to sell, taking a contrarian approach and actually investing a little bit more in your planned investments while they’re down can actually be a great strategy to consider.

As the old adage goes, “What goes up, must come down”.

In investing, however, the opposite rings true as well. And those who are able to weather the storm and either leave their investments intact – or even add to them a little bit – are often the ones who benefit the most.

Final word

It’s human nature to want to chase the shiny new object that seems to be outperforming everything else.

The data doesn’t lie, however; those who do decide to chase these glittering prizes, do so at their own peril.

To maximise your chances of securing the greatest long-term returns possible, it’s tough to beat a simple, patient, buy-and-hold investing strategy.

If you’d like to know more, then get in touch. We’d love to help out!

Disclaimer: The content of this article is general in nature and is presented for informative purposes. It is not intended to constitute financial advice, whether general or personal nor is it intended to imply any recommendation or opinion about a financial product. It does not take into consideration your personal situation and may not be relevant to circumstances. Before taking any action, consider your own particular circumstances and seek professional advice. This content is protected by copyright laws and various other intellectual property laws. It is not to be modified, reproduced or republished without prior written consent.