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Fact
Despite media reports to the contrary, the United States' economic position in the world is likely to sustain itself over the next several decades. By 2050, the U.S. population between the ages of 15 to 64, the most economically active segment of the population, will grow by 42%. Conversely, the same segment in China will decline by 10% and in the European Union it will decline by 25%.
-Derived from “America on the Rise.” Forbes. 2010
Quote
"Recommend virtue to your children. It alone, not money, can make them happy. I speak from experience."
- Ludwig van Beethoven
Inside
Why Chasing Returns is like Gambling Backwards
The United States is on the road to economic recovery, but a slow and unsteady one. As the economy moves from a fragile to stable environment, so too will the financial markets. Certain sectors of the economy, such as healthcare, are likely to recover more quickly while others may chart a slower path.
Diverse recovery timelines will impact the performance of related securities. Financial publications tend to feature securities, mutual funds, and indexes that have experienced sensational returns. In the year ahead, any number of stories will be printed highlighting investors who “succeeded” in selecting investments that generated large returns.
However, the returns featured in these stories are often short-lived, and many investors find themselves in a losing proposition after building an investment strategy based on the featured companies and funds. This approach is known as chasing returns.
Chasing returns is often triggered by a reactive, emotional response of an individual who feels that they have missed out on a high growth opportunity. In that mindset, the investor’s point of view is narrow, considering only a few months of performance and hoping for an instant increase in the months to follow. However, the hoped for return on investment is not likely to be achieved. And, because of emotional influences, the investor is more likely to hold the security for a longer period of time if expected returns are not immediate, potentially causing further damage to the portfolio.
Consider as an example the Nasdaq Composite Index. In 1999, the Index achieved a rate of return of 86% followed by a return of -39% in 2000. Investors who chased the phenomenal return of the Index in 1999 would have experienced significant financial loss in 2000. Those who held the investment longer, hoping to recoup this loss, would have been exposed to returns of -21% and -31% in the subsequent two years. In fact, even those who invested at the end of 1998 and held the Index all four years would have still experienced a significant net loss in their initial investment.*
In many respects, selecting investments by chasing returns is much like wagering on roulette by selecting the number or color that hit on the previous spin. Investors who chase returns by altering their investment strategy based upon a sudden spike in valuation of a particular investment vehicle falsely assume that this spike is repeatable. What is not recognized through this strategy, however, are the causes of the spike.
Swift increases in valuation in many cases are a signal of emerging, unstable businesses. Large percentage returns may be the result of a single, large sale or an influx of investment dollars, rather than real, sustainable growth. As a result, investors who chase returns are inviting securities with high risk portfolios while potentially reducing investments in securities with proven historical growth, altering their portfolio risk.
As the economy continues to rebound, short term gains are likely to be seen in a variety of securities and mutual funds whose companies have received influxes of cash from stimulus dollars, venture capital, or that are rebuilding product inventories. Investors should view these gains as temporary, and should react only by not reacting. Sticking to an investment strategy that focuses on long-term performance remains the best approach.
At Waller Financial, we believe in emotionless investing, built upon a well-crafted financial plan that places the achievement of each client’s long-term goals at the forefront. If you would like more information on how your financial plan is designed to help achieve your personal goals, contact your financial planner today at 614.457.7026.
*”Behaviors to Avoid.” ICMA-RC. 2009.