According to a recent Rasmussen Consumer Index, investors are still down on the economy. While 35% believe the economy is improving, 42% believe conditions are worsening (the numbers for consumers in general being even worse). This study is relatively in line with a MFS “Investing Sentiment Survey,” which found that only 35% of the public thinks US stocks (and 22% of international stocks) are a good place to be these days.
It frightens me whenever feelings come into the conversation on investing. Especially when feelings on the economy parallel feelings about market performance.
Investors can place too much importance on feelings and hunches when they invest; and in times when the economic picture seems in question, they can be prone to investment performance anxiety, as well as making very costly mistakes.
The biggest mistake is often being upset with performance of one investment you own, while measuring it versus one that did better over the past weeks, months, and perhaps years. We second guess ourselves for not investing sooner, feel anxious to miss out on the future for a bright fund, and can be upset we clearly did not do as well as some.
One major item missing from the calculations and regret of investors is realizing not only how the investments you have held have performed, but what your performance has amounted to as you moved in and out of funds based on feelings. While this sounds as if it should be the same, it absolutely is not.
An investors return (known in the industry as the dollar-weighted return) is the calculation of how your investment did considering when you invested, as well as whether you added to or took money from a holding. Perhaps the biggest differentiating factor of investor performance that causes us to make these moves is — our ‘feelings’ about the market and economy.
Consider an investment which you hold a small position which rises 100% in the first half of the year. Watching with great interest and an analytical (but, of course unemotional) eye, what investor could possibly think moving the bulk of their portfolio (all of their ‘lesser’ investments) to this clearly superior manager was a poor move?
But, as happens often, the laws of gravity and ‘return to the mean’ step in, and the fund that had the best performance in the first six months, experiences a 50% drop during the remainder of the year.
Now, the return the fund manager achieved for the year (time-weighted) is flat. She went up, she went down, but ended the year even.
Since you were more heavily invested after the good times, your experience (ignoring for our purposes the first six months and the lost opportunity of being invested in the other funds) is completely different. You felt good about a manager on a hot streak and went all in; only to catch them as their luck changed.
And that often is the case when investors are over confident or fearful about the economy. They tend to make moves at the wrong times, into the hot funds and managers based on recent performance. But as we all know, past performance never is a sign of what the future holds.
The moral of the story? The link between the economy and investment performance is weak to begin with. The link between our feelings of how the two interact is not a guiding compass for a solid investment plan.
The preceding blog was originally published by the Financial Planning Association®(FPA®). To view the original blog please visit the FPA Web site.