The stock market is cheeky. It’s also patient. It baits investors onto one side of a boat. It waits. And it waits. Then it tips them over. When investors recover from the cold-water shock, they climb aboard again. But the market lulls the lot to the boat’s other side. It waits. And it waits. Then it tips them over.
Even the pros get dumped. Take Vanguard’s Emerging Markets Stock Index Fund Institutional Shares (VEMIX).
Investors need at least $5 million just to buy the fund. These are big players. But they’re just as human as you and me. They got royally soaked by the market’s bait and switch. Over the past 15 years, the fund averaged a compound annual return of 8.44 percent per year, ending May 31, 2016. But according to Morningstar, the fund’s typical investor averaged a compound annual return of just 2.57 percent.
Bad behavior drowned their profits. If $10,000 were invested in the fund 15 years ago it would have turned into $33,716. The fund’s average investor turned the same $10,000 into just $14,632.
They were likely seduced by the fund’s volatility. It gained 381 percent between June 2001 and November 2007. Investors, who recognized the market’s great performance, started to pile in. But they must have been buying high.
Then the index started to fall. By February 28, 2009, it had lost nearly 63 percent of its value. Many of the same investors who bought after the market’s rise, must have been selling then.
By mid 2011, the index had nearly fully recovered. That’s when many investors would have bought back in. These aren’t just silly presumptions. It’s the only explanation. When a fund gains an average annual compound return of 8.44 percent but its investors make a compound return of just 2.57 percent per year, we know how it happened. Investors bought when things look rosy. They sold when things looked dire.
Retail investors in Fidelity’s Emerging Market Fund (VEMKX) did much the same thing. The fund averaged a compound annual return of 8.33 percent over the same 15-year period. Investors in the fund averaged a compound annual return of just 3.07 percent.
Like those investors, most of us build faith in sectors when they’re winning. We lose faith in sectors that haven’t done as well.
I’m not suggesting that you should weight your portfolio with this year’s losers. Diversify instead, and keep a steady hand. Following the crowd can easily tip your boat.
The crowd favorite, right now, is U.S. stocks. Here’s why.
During the five-year period ending December 31, 2015, Vanguard’s U.S. Total Stock Market Index (VTSMX) gained 104 percent with dividends reinvested. Vanguard’s International Stock Market Index (VGTSX) gained just 33 percent.
It’s easy to give up on international stocks, after seeing this performance. But investors shouldn’t. Every sector has its day. During the previous 5 years (2006-2011) U.S. stocks lagged. Vanguard’s U.S. Total Stock Market Index gained 10.2 percent. Vanguard’s International Index gained 32.9 percent.
Mark Twain wrote a quote that would serve investors well. “History does not repeat itself, but it rhymes.”
Many investors have likely sold their international index–or reduced their exposure. They’re likely piling up on the U.S. side of the boat. But international stocks are cheap. One day they’ll win again.
We don’t know when and we shouldn’t try to guess. Instead, we should maintain a globally balanced portfolio of low-cost index funds. Rebalance once a year.
Sure, you could try to time the market’s next hot sector. But odds are, you’ll look like a dog chasing its tail.
Don’t fall victim to the market’s bait and switch.
Andrew Hallam is a Digital Nomad. He’s the author of the bestseller, Millionaire Teacher and The Global Expatriate's Guide to Investing: From Millionaire Teacher to Millionaire Expat.