Here’s a number…$380,000 – that’s the amount you’re potentially losing out on if you chase performance and try to “outsmart” the market.
How did we get to that number?
A recent study from Vanguard attempted to quantify the impact of “performance chasing” vs a “buy and hold” strategy. The study found that from 2004 to 2013, a 10yr time period, that the “buy and hold” strategy was the clear winner for every equity style box.
The most popular style box of the 9 different styles is the Large-blend (where the S&P 500 is situated). The “buy and hold” strategy for this category had 6.8% median annualized return over the 10-year time period, while the “performance chasing” strategy had a 4.5% median annualized return.
If you had $1Million dollars in 2004 and “performance-chased” for the 10yr time period, your portfolio would have grown to $1,552,969. But, if you had $1Million dollars in 2004 and incorporated a “buy and hold strategy” for the 10yr time period, your portfolio would have ended up with $1,930,689. That’s the roughly $400,000 difference between “performance-chasing” vs. holding on to your investments.
It’s clear that buying an investment due to its past performance is a terrible predictor of future performance. Even so, most investors try and “outsmart” the market by picking funds based primarily on the funds’ recent performance record. They think they have an edge, but they don’t.
Picture this, you’re driving home from work and there’s traffic on the highway. Some lanes seem to be moving faster than others so you decide to switch lanes. The moment you do that, what usually happens? The lane you just switched from is now moving faster than the one you switched into. That’s performance chasing.
What does this all mean to you?
- First, past performance is not necessarily indicative of future performance, and
- Second, to improve your odds of long-term investment success, you need to understand that some periods of below average performance are inevitable. During these periods, you need to remain disciplined in your investment approach to avoid the temptation of performance chasing.
Bottom line: When it comes to investing there’s no fool-proof way of determining what will outperform in the future. That’s why we are rewarded for taking risks as investors.
Don’t make the mistake of chasing returns. Stick to your plan and focus on what’s best for your long-term financial goals.