It's common practice to look at a fund's total return number for a snapshot of what performance to expect, but that won't give you the full picture. Morningstar studies have shown that investors' actual gains frequently pale in comparison to reported total return numbers. This phenomenon frequently plays out among funds that attract assets after streaks of hot performance, only to see some investors get skittish at the first signs of underperformance. After a moment's though, even a novice investor will realize that this behavior is just the opposite of the mantra -- buy low and sell high.
This practice can be more broadly attributed to bad behavior and lack of a plan or philosophy when it comes to investing. Investors are human and humans are emotional. As much as the logician in me would like to believe my left brain is working to drive my decision making, logic comes in after emotions are experienced to provide context for how we are feeling and not the other way around. To borrow from the existentialists, we as humans have limits to our rational ability.
It is these emotions that cause bad behaviors that then lead to poor investor returns. However, by being consciously aware of how we are feeling (emotions) and how these emotions relate to our thinking (logic), investors can empower themselves to make better decisions. The primary manifestations of investor bad behavior come in the form of market timing, picking stocks, and using past performance or a track record to pick investments that will (hopefully) provide superior performance in the future. These are topics for discussion on another day, but at least be aware of them for now.
Using past performance as a tool for investment selection simply doesn't work. This is counter intuitive for most people and in direct conflict with other areas of our life. For example, if an all-pro NFL quarterback leaves one team for another, it is not unreasonable to expect the quarterback will excel with his new team. Stated another way, the quarterback's performance will persist. However, this is not so in investing. In fact recent stellar past performance by a fund manager may be an indication that you don't want to own that fund.
There is no academic study that I am aware of that has shown that a manager's superior performance is likely to persist into the future. (There are mountains of studies that show just the opposite.) And more importantly, there is no reliable way for an investor to predict what fund manager will have future superior performance in advance or before the fund manager does outperform. Yet hindsight is always 20/20 and investors are emotional. It's a virtual spinning wheel investors tend to run on but one that can be gotten off of by being consciously aware of these behavioral traps.
Click here to read more about investor returns and to see some real life examples of how investors actually fared in funds with strong recent past performance.
To Your Prosperity ~ Kevin Kroskey
This practice can be more broadly attributed to bad behavior and lack of a plan or philosophy when it comes to investing. Investors are human and humans are emotional. As much as the logician in me would like to believe my left brain is working to drive my decision making, logic comes in after emotions are experienced to provide context for how we are feeling and not the other way around. To borrow from the existentialists, we as humans have limits to our rational ability.
It is these emotions that cause bad behaviors that then lead to poor investor returns. However, by being consciously aware of how we are feeling (emotions) and how these emotions relate to our thinking (logic), investors can empower themselves to make better decisions. The primary manifestations of investor bad behavior come in the form of market timing, picking stocks, and using past performance or a track record to pick investments that will (hopefully) provide superior performance in the future. These are topics for discussion on another day, but at least be aware of them for now.
Using past performance as a tool for investment selection simply doesn't work. This is counter intuitive for most people and in direct conflict with other areas of our life. For example, if an all-pro NFL quarterback leaves one team for another, it is not unreasonable to expect the quarterback will excel with his new team. Stated another way, the quarterback's performance will persist. However, this is not so in investing. In fact recent stellar past performance by a fund manager may be an indication that you don't want to own that fund.
There is no academic study that I am aware of that has shown that a manager's superior performance is likely to persist into the future. (There are mountains of studies that show just the opposite.) And more importantly, there is no reliable way for an investor to predict what fund manager will have future superior performance in advance or before the fund manager does outperform. Yet hindsight is always 20/20 and investors are emotional. It's a virtual spinning wheel investors tend to run on but one that can be gotten off of by being consciously aware of these behavioral traps.
Click here to read more about investor returns and to see some real life examples of how investors actually fared in funds with strong recent past performance.
To Your Prosperity ~ Kevin Kroskey