When will investors (and many financial advisors) learn the potential perils of chasing returns?
Take a look at the chart below showing flows into bond funds from 2009 through 2012. Billions of dollars poured in, year after year.
Equity and Bond Flows 2004 – 2013
Meanwhile, despite five-in-a-row positive years for U.S. equity markets, investors fled stocks until the bond market turned sour in 2013, with a 15.1% decline in 30-Year U.S. Treasuries.
It can be very hard to start investing or stay invested when financial markets reach new highs. Our intuition tells us that after a long period of sustained performance maybe “we’re due for a correction.” This intuition is seen in many areas besides financial markets, such as in baseball, when a batter is “due” for a hit after not getting a hit over the past few games. This intuition also appears when gambling, with the belief that you might be “due” to see the ball land on black after a string of red spins at the roulette wheel. Continue reading
In our last post, we talked about the gambler’s fallacy and how it can fool investors into thinking that since there has been a run of good stock market performance, we must be due for a downturn. Now let’s look at the hot hand fallacy.
In sports, the hot-hand fallacy leads one to predict that a player will continue to be hot because his recent performance has been hot; for investors, it is the fallacy that a hot manager or asset class will continue to perform well given recent performance. Continue reading
Imagine showing your clients the annual returns for the S&P 500 index for the past five years, as displayed in the table below.
If you ask each client what they think will be the odds of the S&P 500 earning a positive return in 2014, how do you think they’ll respond?
|S&P 500 Annual Returns
Source: Morningstar Direct, January 2014 Past performance does not guarantee future results. Indexes are unmanaged baskets of securities in which investors cannot directly invest; they do not reflect the payment of advisory fees or other expenses associated with specific investments or the management of an actual portfolio.