In this business we’re constantly telling clients to focus on the long-term. We say things like:
“Don’t pay attention to the day-to-day volatility.”
“Focus on whether or not your investment plan meets your specific goals.”
“Invest energy into the things you can actually control.”
These are all good pieces of advice but sometimes we need a bit more substance to help us keep the faith. In other words, what specific things can we point to in times of uncertainty that will help us focus on the long-term, reduce the stress associated with daily “market watching”, and ultimately have a better investment experience?
This post will be the first in a series that will focus on specific things investors can do to have a better long-term investment experience and ideally better outcomes.
Embrace Market Pricing
The market is really the ultimate information processing machine. Every day, hundreds of billions of dollars cross between buyers and sellers. With each trade, these participants bring new information to the market which helps set prices. These prices aren’t necessarily “right”, and the markets certainly aren’t perfectly efficient, but they’re probably the best estimate we have of actual value.
So what’s the main thing to focus on here? Embrace market pricing and don’t try to outguess or time the market – by doing so you’re essentially saying you know more than the collective knowledge of all market participants. Here’s a snippet from The Economist that uses an example from a popular game show to help illustrate this “wisdom of crowds” concept:
“Take, for instance, that corny game show, “Who Wants To Be A Millionaire?” Across a large sample of shows, those contestants who took the option to call an expert for an answer got it right almost 65% of the time. But the ones who asked the studio audience—hardly a gathering of gurus—did far better; they got it right 91% of the time. And that, it seems, was no fluke. Get a group to guess something—the number of jellybeans in a jar—and only a small minority of individuals will be closer to the correct answer than the average estimate.“
–“Collective Intelligence”, The Economist, May 27th, 2004
Resist Chasing Past Performance
This is a big one, and its easier said than done. When a security, mutual fund, or other asset takes off in price, people notice and want a piece of the action. Whether it’s Bitcoin, a hot new manager, or the next stock du jour, investing in these assets merely because they’re going up is a losing game.
How can chasing performance go wrong? Lets use the above chart as an example. What it shows is that only 26% (32% for bond managers) of equity mutual funds that ranked in the top 25% of their peer group for a 3 year period also ranked in the top 25% over the following 3 year period – meaning that past performance offers little insight into a fund’s (or any asset for that matter) future returns.
Vanguard has looked at this idea of performance chasing versus a buy and hold type of strategy in a fair amount of depth. The below is a chart from a study done in 2014 where they simulated a performance chasing strategy across the major US equity asset classes (click here to read the full methodology) and compared it to a buy and hold strategy.
The study’s conclusion reads in part:
“…a buy-and-hold strategy has outperformed performance-chasing over the past decade in all nine Morningstar equity style boxes.”
And here’s the key:
“To improve the odds of their long-term investment success, investors should understand that some periods of below average performance are inevitable. At such times, investors should remain disciplined in their investment approach and avoid the temptation to chase performance.”
So the next time someone says to you “don’t chase that new hot stock” or “its not worth it to try and outguess the market” hopefully you’ll be able to point to a few reasons why you should keep the faith.
Next week in part 2 of this series, we’ll discuss looking beyond news headlines, managing the emotions of investing, and characteristics of a sound investment plan.
Have a good weekend.
Published by Gemmer Asset Management LLC The material presented (including all charts, graphs and statistics) is based on current public information that we consider reliable, but we do not represent it is accurate or complete, and it should not be relied on as such. The material is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction where such an offer or solicitation would be illegal. It does not constitute a personal recommendation or take into account the particular investment objective, financial situations, or needs of individual clients. Clients should consider whether any advice or recommendation in this material is suitable for their particular circumstances and, if appropriate, see professional advice, including tax advice. The price and value of investments referred to in this material and the income from them may fluctuate. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Fluctuations in exchange rates could have adverse effects on the value or prices of, or income derive from, certain investments. No part of this material may be (i) copied, photocopied or duplicated in any form by any means or (ii) redistributed without the prior written consent of Gemmer Asset Management LLC (GAM). Any mutual fund performance presented in this material are used to illustrate opportunities within a diversified portfolio and do not represent the only mutual funds used in actual client portfolios. Any allocation models or statistics in this material are subject to change. GAM may change the funds utilized and/or the percentage weightings due to various circumstances. Please contact GAM, your advisor or financial representative for current inflation on allocation, account minimums and fees. Any major market indexes that are presented are unmanaged indexes or index-based mutual funds commonly used to measure the performance of the US and global stock/bond markets. These indexes have not necessarily been selected to represent an appropriate benchmark for the investment or model portfolio performance, but rather is disclosed to allow for comparison to that of well known, widely recognized indexes. The volatility of all indexes may be materially different from that of client portfolios. This material is presented for informational purposes. We maintain a list of all recommendations made in our allocation models for at least the previous 12 months. If you would like a complete listing of previous and current recommendations, please contact our office.