A Dumb Investment Mistake Even Smart People Make
A couple of years ago, I was giving an investment presentation at the Radisson Blu Resort, on the Mediterranean island of Malta. Afterward, the company’s manager invited my wife and me to dinner. I sat beside a wealthy British man who made his fortune in real estate.
“I was fascinated by your presentation on index funds,” he said. “I’ve been investing in the stock market for about ten years, and I have to admit, I’ve never made money.”
I was surprised, considering the previous ten years represented one of history’s easiest decades to make money in stocks. For example, from January 2009 to December 31, 2019, a $10,000 investment in a US stock market index more than quadrupled in value to $44,845. The same investment in a global stock index swelled to about $34,285.
“What did you buy?” I asked.
“I kept buying the top-rated funds,” he said. “Sometimes, I bought them on my own. Other times, I hired an advisor to help me. I’ve made money on some of the funds, but overall, I don’t think I’ve made a profit.”
So I asked, “How did you determine the top-rated funds?”
“I found out which funds had the best performance over the previous year,” he said.
Intuitively, that makes sense. These funds grace the cover of financial magazines. They’re discussed on investment forums. They’re also given top honors at year-end mutual fund awards.
Unfortunately, buying last year’s top-performing funds is a bit like peeing in your own bathwater. Financial academics explain this with something they call, “reversion to the mean.” Funds that perform well over one time period rarely repeat their winning ways. The SPIVA Persistence Scorecard provides proof every year.
Unfortunately, people typically buy the previous year’s winning funds after they have performed well. My friend in Malta was no exception. And after doing so, those funds often sink.
Consider the City Wire USA article, The Best and Worst Funds of 2020.
They listed the ten best performing actively managed mutual funds in 2020. They included the Morgan Stanley Institutional Discovery Fund (MPEGX) that gained 154.3 percent; the Zevenbergen Genea Fund (ZVGIX), which gained 153 percent; and the Morgan Stanley Institutional Inception Fund (MSSGX), which gained 152.6 percent.
But anyone seduced by those gains that bought those funds at the beginning of 2021 would be disappointed now. From January 1, 2021, to December 28, 2021, they dropped 11.55 percent, 3.11 percent, and 3.57 percent respectively. In other words, they lost money over the same time period that the S&P 500 index gained more than 29 percent. Only two of those former top ten funds earned a profit this year.
What’s more, the ten worst performing funds in 2020 thrashed the former “top-performing” funds in 2021.
This doesn’t mean you should invest in the worst-performing funds in any given year. Instead, ignore fund performance. Build a globally diversified portfolio of low-cost index funds or ETFs. You won’t be able to brag that you own, “The best funds of the year!” But over your lifetime, you will thump the returns of those who chase their own tails.
Reversion To The Mean Is Real
*to December 17, 2020; Source: The Best and Worst Funds of 2020
**to December 28, 2021; Source: Morningstar.com
Andrew Hallam is a Digital Nomad. He’s the author of the bestseller Millionaire Teacher and Millionaire Expat: How To Build Wealth Living Overseas
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