“Successful investing,” Warren Buffett has said, “takes time, discipline and patience.”
If only all investors heeded Buffett’s words. In reality, too many look for shortcuts to success—shortcuts that almost always lead to dead ends. A prime example: Continually seeking out the “best,” whether it’s the hot mutual fund manager of the moment or a soaring asset class.
What’s wrong with wanting the best? Nothing, except for the fact that no investment manager, or investment, remains the best for long. And when they stumble, you can expect to pay the price.
Consider a recent study from S&P Dow Jones Indices. Over a five-year period, it found, 99% of large- and mid-cap mutual funds in the top performance quartile failed to keep up that performance over five years. What’s more, more than 25% of those once-hot funds sank to the bottom performance quartile over the study’s timeframe.
The same holds true for asset classes. Of the 10 main fixed-income asset classes, high-yield bonds performed the best in 2013, with a 7.4% return. But the next year, high-yield bonds sank to ninth place on the list, with a return of just 2.5%.
In the equity arena, small-cap stocks were the best asset class in 2013, returning 38.8%. In 2014, however, they returned 4.9%, dropping to the middle of the pack.
A strategy of chasing the winners just cannot compete with a strategy of disciplined, patient investing. Take another study, from the Vanguard Group. Examining a decade’s worth of data, Vanguard found that investors using a patient, long-term strategy beat those who chased performance by more than 1.5% a year, on average.
One of the problems with an impatient approach is that it’s expensive. Impulsive investors tend to sell investments that have lost ground in order to buy those that are on the rise. In doing so, they commit the cardinal investing error of buying high and selling low. Locking in their losses, these folks use their diminished capital to buy smaller stakes in another investment. This is reverse compounding, and it can shrink your wealth with alarming speed.
Among the most often cited disclaimers in the investment industry is that past performance is no guarantee of future results. Simply put, there is zero statistical correlation between the past and future performance of any investment.
Sure, a tiny percentage of hot managers may keep post strong performance for more than a year. But there is no way to identify these managers before their run of success occurs.
A sound investment strategy doesn’t revolve around betting on managers, asset classes, or particular investments. It starts with identifying your goals, risk tolerance and time horizon, and then building an investment portfolio to help you meet your long-term objectives.
Patience and discipline may not be as fun as chasing performance. But by helping you to come out ahead in the long run, that approach can be a whole lot more satisfying.