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Sticking with Your Strategy
Don't Chase Investments Based on Sizzling Returns
Changing investment strategies based on the past performance of a particular investment can be a buy-high strategy that could leave you with disappointing investment returns.
Avoiding Rearview Mirror Decision-Making
Chasing the latest hot mutual fund or stock is an example of "rearview mirror" investing. Typically, rearview mirror investors watch the sizzling returns from a particular investment and buy in, hoping to realize similar returns. But their timing is generally off. Often, the biggest gains have already been recognized before the investment gets enough publicity to attract the attention of the rearview mirror investor.
Assume, for example, that a mutual fund with a $20-per-unit value rises to $30, earning $10 per unit for the early investors. The performance attracts media attention and rearview mirror investors jump in at $30 per unit, or higher. Now the fund runs into a slow period and the units drop to $25 each. The early investors still made a tidy profit. The rearview mirror investors have lost $5 per unit, as shown in the following chart.*
Rearview Investing Usually Doesn't Work
* This hypothetical illustration is for example only. The rates of return mentioned are not intended to reflect the performance of any actual investment. Investments do not typically grow at an even rate of return and may experience negative growth.
Some investors made similar mistakes with emerging-market stocks a few years ago. Investors who, as part of their diversification strategy, had allocated a portion of their portfolio to foreign stocks enjoyed strong market gains. Predictably, these returns attracted media attention and the rearview mirror investors joined in — just before these markets took a tumble.
Diversification — Designed for a Smoother Ride
While current emerging market returns may be disappointing, they offer some evidence that diversification works and that rearview mirror investing can lead to disappointment. A diversified portfolio is designed to provide a smoother ride for the investor by spreading risk among investment types. By definition this means a diversified portfolio could include, at any one time, some of the hottest and some of the coolest investment options.
Currently, emerging market returns are disappointing to many, and rearview mirror investors have moved on to other opportunities. Long-term, diversified investors don't chase the latest trend, however, and many maintain some foreign-market investment. Diversified investors generally expect that some of the best investments could be part of their portfolios — at the beginning of their cycle, not at the end.
Rearview mirror investing is, by nature, based on past performance. And allocating your assets based on past performance is simply not a good substitute for focusing on your specific investment goals and sticking to a long-term strategy.
Nothing contained in this publication is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional.
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