In the world of investing, patience is more than a virtue – it’s a fundamental key to success. However, many investors often find themselves tempted to abandon their long-term investment strategies when they hear about another advisor or friend boasting superior returns over a short period, say, a three-year timeframe. This is a common error that can potentially lead to devastating financial consequences.
Let’s delve into why this is a grave mistake and how investors can stay the course, even when another advisor’s grass appears greener.
Understanding the Nature of Market Cycles
The first thing to understand is the cyclical nature of markets. Market cycles are periods of time during which markets go through stages of growth, peak, decline, and trough in a somewhat predictable pattern. Depending on the investment strategy an advisor follows, they might outperform in some cycles and underperform in others.
An advisor who had stellar performance over the past three years might have simply taken advantage of a specific phase in the market cycle aligning with their strategy. However, that doesn’t guarantee they’ll continue to outperform in the future.
For example, let’s say you hear about another advisor who “just hit it over the past few years” and their philosophy overweighted Commodities and US equities- as you can see from the table below they would clearly outperform in the past three years since those asset classes were en vouge over time as you can see from the chart below, that does not work so well.
Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index.
Sources: BlackRock Investment Institute, with data from Refinitiv Datastream, 1 August 2023.
Notes: The table shows annual index total returns (income or dividends reinvested) in U.S. dollars, indices are unmanaged and therefore not subject to fees. 2022 shows year to 31 July 2023. Indexes or prices used are: U.S. equities – MSCI USA Index, EM equities – MSCI Emerging Markets Index, Europe equities – MSCI Europe Index, Japan equities – MSCI Japan Index, China equities – MSCI China Index, DM gov. debt – Bloomberg Barclays Global Treasury Index, Emerging debt – JP Morgan Emerging Market Bond Index (EMBI) Global Composite, High yield – Bloomberg Barclays Global High Yield Index, IG credit – Barclays Global Corporate Credit Index, Commodities – Commodity Research Bureau (CRB) Index, Cash – Bloomberg Barclays U.S. Treasury Bill Index, REITs – S&P Global Real Estate Investment Trust (REIT) Index, Infrastructure – S&P Global Infrastructure Index. Annualized column shows the annualized total return over the last 10-years from< 31 July 2023
The Illusion of Short-Term Success
Measuring performance over a short time frame, like three years, can be misleading. It often doesn’t provide enough data to truly assess an advisor’s ability to manage risk and generate consistent returns over the long term. Some studies have even shown that funds that outperform in one period are more likely to underperform in subsequent periods, a phenomenon known as “mean reversion”.
Risk Tolerance and Investment Goals
Every investor has unique financial goals and risk tolerance. A strategy that generates higher returns often comes with higher risk.
When an investor abandons their initial investment strategy (which was presumably tailored to their risk tolerance and goals) for a high-performing one, they might end up taking on more risk than they’re comfortable with, potentially leading to significant losses.
I like to compare this to air travel, which may seem strange, but please indulge me for a moment. Let’s say I want to fly from JFK in New York to LAX in California it will probably take me around five hours of flight time. If my friend boards a supersonic jet flying at Mach 2 he will probably be there in about 45 minutes. Personally, as much as I would love to save time, my risk tolerance of flying Mach 2 and dealing with G forces is something to which I am adverse. I am happy cruising at 35 thousand feet with little turbulence.
My point is that something with faster or higher returns is most likely taking on significantly more risks than you and those risks may not align with your financial plan and overall personal investment risk profile.
Staying the Course
The best course of action for most investors is to stick with their long-term investment strategy, even when it seems like they’re missing out on better returns elsewhere. Remember, investing is a marathon, not a sprint. Staying disciplined, being patient, and keeping a long-term perspective are often more beneficial than constantly chasing the top performer.
While it’s natural to be attracted to advisors boasting superior short-term returns, it’s crucial to understand that these returns may not be sustainable and that switching strategies can come with significant risks and costs. A sound investment strategy is designed to weather the ups and downs of market cycles, providing a path towards achieving long-term financial goals.
As the legendary investor Warren Buffett once said, “Our favorite holding period is forever.” Before you consider jumping ship based on a three-year performance, remember that patience and persistence often win the race in the world of investing.