Thursday, September 3, 2009

Chasing Return = Certain Failure

There are few things more frustrating than when your fund or stock pick is under performing or lagging the average industry return. This frustration often leads to the largest set back a pilgrim could have on their savings journey - chasing returns.FailureA return chaser buys one hot fund and then once it turns cold jumps to the next hot fund – the catch is, that by the time they identify a hot category and make the decision to switch the new fund may have already begun to turn cold. All the while the old fund may now be poised to take off.

There are no clear signs when to switch or where to switch and when information becomes evident to aid you in your decision it is probably already too late. Meir Statman said it beautifully in a recent Wall Street Journal piece, here is an excerpt from the article:

Goldman Sachs is faster than you.

There is an old story about two hikers who encounter a tiger. One says: There is no point in running because the tiger is faster than either of us. The other says: It is not about whether the tiger is faster than either of us. It is about whether I'm faster than you. And with that he runs away. The speed of the Goldman Sachses of the world has been boosted most recently by computerized high-frequency trading. Can you really outrun them?

It is normal for us, the individual investors, to frame the market race as a race against the market. We hope to win by buying and selling investments at the right time. That doesn't seem so hard. But we are much too slow in our race with the Goldman Sachses.

So what does this mean in practical terms? The most obvious lesson is that individual investors should never enter a race against faster runners by trading frequently on every little bit of news (or rumors).

Instead, simply buy and hold a diversified portfolio. Banal? Yes. Obvious? Yes. Typically followed? Sadly, no. Too often cognitive errors and emotions get in our way

From: The Mistakes We Make – and Why We Make Them by Meir Statman

If you really want to delay your summit of the mountain we call financial freedom, all you have to do is start chasing return. I recommend a well diversified portfolio of varied funds so that no matter what the market is doing, at least a portion of your money is doing well.

It isn’t very sexy and it doesn’t have the excitement of a hot tip, but there is no better way to improve your odds for financial freedom.

Listen, everyone says they are a long-term investor until things start to get tough – then they want out. Do not let your emotions or fears drive you to make bad decisions. If you are questioning the diversification of your current portfolio please give me a call. I would be happy to review your current allocation structure and tweak it to the right mix for you.

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