Here are two ways to incinerate your financial plan:
Panic selling your investments at the absolute worst time during a period of market drawdown.
Abandoning a perfectly sensible investment strategy in order to chase performance elsewhere.
This profession of ours tends to focus on the first risk. As financial planners, we spend lots of time with clients at the outset of a relationship explaining how their investments may behave during periods of market difficulty. We put numbers around this, and set out how we stand ready to coach them through to the other side when the world seems very dark.
But we spend less time focussed on how we might protect people from the second risk - and it is no less pernicious. In a world full of endless choice, there is a constant and overriding temptation to abandon ship and chase the new bright and shiny financial object.
The world seems quite bright and shiny at the moment. Many stock markets globally are at all time highs. Gold and bitcoin too. A couple of weeks ago Nvidia added $276bn to its market cap in a single day.
In other words, we are BACK.
We aren’t quite back to the madness of 2021, but the hype machine is definitely starting to fire up again.
In this kind of an environment, the returns provided by a suitable and rationale investment strategy may seem positively pedestrian. It is likely that many assets out there will be performing far better than your boring old portfolio.
Nothing in this life is as infuriating as seeing someone that you know, even if that someone is just on the internet, getting really rich, really quick.
Therefore it can be immensely tempting to want to jump onto the bandwagon that they have ridden successfully, in order to bask in the reflected glow.
Until that particular train begins to run out of steam, and then we move onto the next one. And then the next one.
This kind of performance chasing is akin to playing “whack a mole”. Just when you’ve hit upon the shiny, new thing - it disappears and another pops up elsewhere.
It’s more of a pastime than a strategy, and an utterly exhausting one at that.
The financial media, and large swathes of the investment industry, are not really in the investing business at all. They are in the ideas business. Someone only gets paid when something happens.
So they are more than happy to shill new ideas to performance chasers desperate for a quick fix. Best buy lists, fund research, stock ideas delivered straight to your inbox. Don’t just sit there - do something!
Each of these communications provides a compelling opportunity to abandon the water tight, rock solid financial plan that you have painstakingly built in favour of some totally unknown quantity which looks great on paper. But as they say “the grass is always greener on the side that’s fertilised with bullshit”.
It is crucially important to bear such lessons in mind at a time like this, when everything is going up and past performance records look particularly seductive.
Because performance chasing isn’t just sub-optimal. It can have a catastrophic impact on your overall outcomes. We have seen, time and again, how there can be a huge gap between the returns generated by a given strategy on paper, and the actual real-life returns experienced by the average investor in that strategy.
Per Nick Murray - “It is too little remembered that the best-performing equity mutual fund of the first decade of the current millennium (2000-2009) returned a blazing 18.2% per year. (It ran like Secretariat in the Belmont: the second place finisher did a mere 14.8%). But its average investor return (that is, the fund’s all-important Dollar weighted return) was a negative eleven percent. You read that right: it’s eleven per cent with a minus sign in front of it.”
How on earth can the average Dollar invested into a fund get such a massively different outcome to the returns offered by that same fund during the same period?
This is because the average investor in this particular strategy, during this particular time, behaved appallingly during the time that they were invested. Money flew into the fund when the strategy was performing well, and stampeded for the exit during tougher times.
For a more recent example, I refer you to the ARK Innovation ETF. Cathie Wood, who did a blisteringly good job of marketing her strategy during COVID, took massive inflows into the fund during 2020 and the first half of 2021 during a period of ridiculously good performance.
These inflows came just in time for the strategy to get massacred through H2 2021 and 2022. Because so much money came into the fund around the peak, there was again a huge discrepancy between investor outcomes and the "on paper" performance of the fund from its inception in 2014 to June 2023. During this period the ARK Innovation ETF put up annualised returns of 9.6%, while the average invested Dollar experienced an annualised -25% loss.
Again, you read that correctly.
The best performing funds, because they tend to be the most volatile, have a habit of swinging from the top of the pops to the bottom of the league.
If you are investing based on past performance alone, you will simply not have the conviction to stick with a strategy through a period of underperformance, and are doomed to find yourself trapped in a cycle of buying high and selling low. Repeat until broke.
As ever the answer is to invest in a simple, rules-based, low cost investment strategy in line with an asset allocation that fits with your circumstances and needs. And then go and read a book or something.
However if I have made one mistake in my career, and I have made a few, it is that I have been too quick to whack people over the head with the textbook over the years.
We are all humans, not robots, and some of us may enjoy the thrill of having a dabble into a stock or strategy that sits outside of the core of our financial plan. You might want to support a friend’s new business, or like researching and investing in new and exciting tech companies.
If this is you, and it’s a hobby, then that is awesome. I get it, I’ve been there.
Just, please, try to scratch that itch cheaply and keep such “off plan” investments to a low proportion of your overall wealth. 5% would be a sensible number.
And please try to remember that performance, for its own sake, is not a financial objective.
The investments that drive your financial plan will fall in value from time to time, and they will probably lag the bright and shiny thing in an environment like we are in today.
But we can deal with this, because our portfolio is backed by a plan and that plan’s foundation is rooted in its purpose. By taking the time to truly understand what the money is for, we give ourselves the best chance possible of reaching our goals.
As ever, none of the above constitutes investment advice and past performance is not indicative of future returns.
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