Chasing Returns

Behaviors to Avoid

Like fishing, the topic of investing always includes stories of the one that got away. Pick up any publication on investing and you will see list after list of the “best” mutual funds and their extraordinary returns. If you act on these lists by changing your investments, you are engaging in the behavior known as chasing returns.

The problem is that extraordinary returns in one time period are frequently followed by losses in the next time period. Take as a recent example the sharp rise and fall in the Nasdaq in the years 1999 and 2000. In 1999 the Nasdaq Composite Index returned an extraordinary 86%. If you had “chased” this return by investing in the index at the beginning of 2000, you would have been in for a sharp disappointment. In 2000 the Nasdaq Composite Index returned -39% and in 2001 and 2002 it returned -21% and -31% respectively. A $10,000 investment in the Nasdaq Index at the end of 1999 would have been worth only $3,307 at the end of 2002. Even if you had invested at the beginning of 1999, experiencing the 86% gain, your $10,000 investment would have been worth $6,136 at the end of 2002.

The important point to remember is that short-term extraordinary gains are not reliable. However, by sticking to a well thought out investment strategy, you increase your chance of taking advantage of the historically better returns that come with investing in equities. Just remember that long-term returns for the market as a whole have been positive. So avoid overreacting to short-term changes and focus on the long term.