Chasing the hot mutual fund or segment of the market rarely works. Let’s consider a typical scenario that investors go through when reviewing their 401k statement.
Dave is a hard-working father of two who lives well within his means. He recognizes the value of saving pretax and aims to take advantage of compound growth by deferring as much as possible from his salary into his company’s 401k plan.
Each January, Dave looks at his statement to see how his account has performed. Unfortunately, his account is only up 7% for the year while the S&P500 notched a gain of 12%. Not feeling too good about his return, Dave proceeded to look at all the funds offered through is 401k plan. He identified the funds that performed well over the past year that he didn’t already own and transferred assets into those funds that had produced the best returns. Sounds reasonable, right?
Twelve months later, Dave takes the time to review his 401k statement in detail again. His account is up 6% for the year while the S&P500 gained 10% for the same time period. The same result as last year. In fact, Dave diligently has been reviewing performance of the funds in his account each January for the last five years and moving money to those that are the highest performers. Why then does the performance of his account consistently lag the performance of the stock market in general? Dave is not alone. He has fallen into the same trap as countless other investors: chasing investment returns.
What may seem like a logical strategy is actually one of the most dangerous approaches to investing. In order to move money around between mutual funds and various segments of the market and to be successful in doing so, Dave would need to be either really lucky or be able to predict future performance before it happens, not after the fact. Investment hindsight is always 20/20.
Don’t get caught chasing returns. It is a game you can’t win over the long-term. Identifying your tolerance for risk, then employing a strategy that offers the optimal blend of funds that will maximize your return potential for whatever level of risk you are comfortable with, is the approach that makes an investor successful.
This article is for educational purposes only and is not a personal recomendation of any strategy or product. You should not make any changes to your financial situation based only on this article. It is advised that you consult a qualified advisor and tax professional to evaluate your situation before making any changes to your finances.