From Chasing Gold to Chasing Your TailMonday, June 15th, 2009 by Charles Mayfield, CFP®
The recent months in the equities market have seen some pretty serious returns. Are we over this slump? Is the future going to be bright from here on? If you know Cass and me, you know that our philosophy on the market is reasonably consistent whether up or down. Our mantra is to develop a plan and stick to it. There will be times when most plans will require minor changes to adjust for different life circumstances. However, for many of our clients…now is not one of those times.
You may remember my blog posting from September 15th, 2008 (http://atlantaplanningguys.com/?p=28). I believe we were in the midst of the downward spiral at that time. I think Cass and I went a solid week of daily posts and all of them market related. My post in September had to do with avoiding those knee jerk reactions to market fluctuation. Staying the course in good and bad times and standing fast by the portfolio and plan that had been put in place is of the utmost importance. This was certainly applicable in September of 2008 and now with several months of pretty strong performance under our belt, I believe, still holds true today.
One of the biggest issues we see when markets are on the way up is constant chasing of the leaders. I liken it to a dog chasing its tail. That dog will likely never catch its tail and will ultimately end up really tired and dizzy. We are coming to the end of the second quarter. Those performance reports will come out for your IRA’s, 401k’s and other accounts. Don’t chase returns. Let me create a classic example for you. (This is hypothetical and for illustrative purposes only. Actual results may vary):
John is 46 years old and has worked for his company for 12 years. He has built a nice nest egg by constantly investing in his retirement plan and has a very diverse portfolio. John stayed invested through the market decline and continued to defer money every paycheck. He pulled up his account yesterday just to see how things were doing and noticed something interesting: his international emerging growth investment had grown 37% in the last two month. John knows he has another international investment in his portfolio and it only gained 22%. What does John decide to do? John does what most folks would have the tendency to do…click a few buttons with his mouse and sell the investment that only gained 22% to purchase more of the investment that grew 37%.
Ask yourself, what John has done that’s so wrong. The mistake I want to focus on is his complete removal of an asset class in his portfolio (international large cap). John has decided to chase after the performance of his emerging investment and is comparing its performance to a completely different kind of investment (one in a different asset class). This would be like firing your plumber and hiring an extra electrician. You don’t need two electricians. What you need are both and if you aren’t happy with the job one of them is doing…go replace them properly.
Take a look at this chart that tracks the performance of several major asset classes over a 10-15 year term. You will notice that rarely is the same sector the leader from year to year. In most cases, you can see patterns of several years at the top followed by several years at the bottom.
When you open that statement in the coming weeks, don’t be so quick to chase the best performers. Pay attention to how your investments stacked up to their peers and benchmarks…not one another.
Chart courtesy of Prudential, 2007.