Q. International stocks are doing really well, so I’m thinking about investing more money into them. What do you think?
Explore This Issue
ACEP Now: Vol 36 – No 12 – December 2017A. I grew up playing ice hockey and continued to play in high school, college, and even now. Coaches often gave us the same advice that hockey legend Wayne Gretzky’s dad gave to him: “Skate to where the puck is going to be, not where it has been.”
Ice hockey is a fast-paced game where the participants are constantly moving, often at full speed, and the ability to read the play and get ahead of it is critical to success. In recent years, this quote has been pulled into the business world and is often used to encourage innovation, attempting to figure out what products consumers are going to want to buy in coming years. However, it can also be applied to individual investors and their portfolios.
Investors’ brains are wired such that the natural tendency is to invest money into asset classes that have done well in the recent past. Recency bias, as it is termed, is the human tendency to assume that recent trends will continue. When investors see that an investment asset class, such as international stocks or real estate, has done well recently, they assume that it will continue to do so. They not only keep their money invested in those classes, they also double down on the bet by investing more. They may even sell other assets that haven’t done as well to pile more money into that asset. Investors are truly skating to where the puck has already been.
The problem with this approach is that the various asset classes tend to go through cycles, and when an asset class has performed well, it may be more likely to do poorly than well in the near future. This comes down to valuations. This may be most easily understood by looking at a bond (ie, a loan to a company or government). As the value of the bond goes up, its yield—or how much you get paid per dollar of value—goes down and vice versa. Stocks and real estate properties work the same way: The less you pay for the asset, the higher your profits per dollar invested.
Performance Chasing Can Leave You Behind
The tendency to skate to where the puck has been in investing is called performance chasing, and it can be hazardous to your wealth. It is difficult to avoid because it is so natural to do. In addition, the financial media encourages this behavior by highlighting investments (and their purchasers) that have recently done well. This can be seen in newspapers like The Wall Street Journal, magazines such as Forbes and Money, and television stations such as CNBC. Even radio show gurus get in on the act, encouraging you to pick mutual funds primarily based on their past performance. Well, there’s a reason that mutual funds are legally required to tell you that past performance doesn’t indicate future performance—because it’s true!
Performance chasing causes investors to buy high and then sell low as they move their money into the new “hot” investment, repeating this flawed process. You don’t have to buy high and sell low very many times in your career to completely sabotage your retirement plans. As Warren Buffett has said, “When hamburgers go up in price, we weep. For most people, it’s the same with everything in life they will be buying—except stocks. When stocks go down and you can get more for your money, people don’t like them anymore.”
This tendency is easily displayed by looking at mutual fund cash flows. When stocks do poorly, people take money out of them, and when they do well, people invest more. Stock mutual fund cash flows were negative from late 2008 to 2012 before turning positive in 2013 to 2014, well after stocks had recovered from the bear market associated with the global financial crisis. Meanwhile, those investors who bought (or simply didn’t sell) at market lows were handsomely rewarded. Bond cash flows showed the opposite, with money coming in from 2008 to 2012, then out in 2013 to 2014. Herd mentality might help groups of animals in the wild avoid predators, but it doesn’t help investors achieve the returns they deserve. Most of the time, investors are rewarded most for their willingness to sit on their hands and follow a simple, boring written investment plan over decades.
Performance chasing between mutual funds within a given asset class can be just as dangerous as performance chasing between various asset classes. Investing giant Vanguard performed a study looking at performance chasing and discovered that, between 2004 and 2013, this dangerous practice cost investors a 2 percent to 3 percent per year performance drop in every asset class they looked at.
Unfortunately, when it comes to investing, figuring out where the puck is going is just as hard to do as not skating to where it has been. Lots of self-styled “contrarians” think that just avoiding the crowds will lead to investing success, and they wander off into areas of the market that never have, and never will, perform well. To make matters even more confusing, markets do exhibit “momentum” to a certain extent. That is, something that performed well recently continues to perform well not because of any underlying economic fundamentals but simply because it has done well recently and investors are still piling into it, chasing performance.
What to Do Instead
It turns out that the winning strategy, returning to our analogy at the ice rink, is to get the players on your team to play their positions. By doing that, no matter where on the ice the puck goes, you have a player nearby to pick up the puck. The way you get your investing “players” to play their positions is by developing a written investment plan where a certain percentage of the portfolio is dedicated to a given type of investment. Perhaps your plan is 40 percent of the portfolio in US stocks, 20 percent in international stocks, 20 percent in bonds, and 20 percent in real estate. After a year, the portfolio will deviate from these percentages because one of these asset classes performed better than the others during that year, even though nobody had any idea which asset class it was going to be at the beginning of the year. So wise investors rebalance the portfolio, returning it to the original percentages. This encourages investors to invest rationally, rather than emotionally, and forces them to sell high (the asset class that did best) and buy low (the asset class that did the worst).
In any given year, the best asset class may be stocks, bonds, or real estate. No matter what happens, your portfolio, if adequately funded, will perform well enough over your career to reach your investing goals, allowing you to sleep well at night. If you find yourself wanting to skate to where the puck has already been, go back to your written investment plan to help you stay the course. If you don’t yet have a written investment plan, you need to write one, either on your own or with the assistance of a competent, fairly priced adviser.
Pages: 1 2 3 | Multi-Page
2 Responses to “Chasing Markets Can Be a Poor Long-Term Investment Strategy”
January 14, 2018
Devin WoelzleinContrarian opinion: investing in only paper assets is also a poor long-term strategy. Most of these portfolio recommendations are coming from financial advisors who are trying to sell you various paper assets, or who only know paper assets.
The bond market is finally turning after a historic 30 year bull market run.
Stock market PE ratios are well into bubble territory (PE ratio is price per share divided by earnings of the company per share with fair value being 12-15) and currently sit at 33.8 (Jan 13, 2018). The only times where stocks were this overvalued were right before the 1929 crash that started the Great Depression and the 2000 Dot-bomb bubble. If you are just now investing and plan on betting long on the stock market (that prices will continue to rise), you are chasing the market. I recommend paying for a subscription service to help you. Source: http://www.multpl.com/shiller-pe/
Investment in real estate is a good idea, but it refers to real estate that pays you regularly for owning it. Examples include apartment buildings, condos, farmable land, and other commercial holdings. Owning a second home to rent out does pay you, but its value is tied to the market, and we all know what happened to that 10 years ago.
The real “old money” families, those in Europe who survived centuries of war, pillaging, and regime changes, focused on the “one third, one third, one third” strategy. The thirds are land, gold, and fine art. (Source: one of James Rickards’ books, and I forget if it is The Big Drop or The Road to Ruin.) Fine art is a portable store of value, and it refers to art done by the artists that most people have heard of. It will hold value in a crisis.
It would also be a good idea to invest in gold and silver (real bullion, not futures contracts and not collector coins). These assets are real money that have held value for all of human financial history, and they will continue to do so. All modern currencies are fiat (backed by nothing except government declaration) since Nixon took us off the gold standard in 1971. Gold and silver are undervalued currently because the commercial traders (working for the world’s biggest banks) are continuously shorting the gold and silver futures contracts, and therefore manipulating the spot price artificially low. You can put gold and silver in your IRA but not into a 401K.
As for cryptocurrencies, there is money to be made here, but be extremely careful. These trade on the only free markets left, and so are subject to high volatility. My best advice is to find an expert and follow their lead, especially when it comes to picking one to invest in and when to get out.
Sources for more information:
1. Mike Maloney’s “The Everything Bubble” and “Hidden Secrets of Money” series. I recommend starting with episode 4 if you watch the Hidden Secrets series (YouTube). He also has the #1 book on investing in gold and silver.
2. James Rickards books The Big Drop and The Road to Ruin.
3. Ron Paul’s Liberty Report (YouTube)
4. demonocracy.info has some very impressive graphics regarding economics.
January 29, 2018
James M. Dahle, MD, FACEPI wish to thank Dr. Woelzlein for reading and commenting on my recent ACEP NOW column entitled “Chasing Markets Can Be a Poor Long-term Investing Strategy.” The purpose of the article was to warn physician investors against the well-known behavioral finance error of performance chasing(1), not to serve as an all-encompassing “how-to” guide to investing.
I agree with Dr. Woelzlein that adding non-correlated assets to a traditional stock and bond portfolio can potentially improve returns and reduce risk. Some investors will choose to stick with a traditional portfolio, others will add non-traditional asset classes in moderation, and still others will take extreme positions that increase the risk of not reaching investing goals. When adding additional asset classes to a portfolio, I would caution an investor to ensure the asset class has low correlation with the rest of the portfolio, positive after-inflation returns, and a reasonable amount of liquidity, accessibility, and tax-efficiency.
Dr. Woelzlein suggests that following a “subscription service” (typically an emailed newsletter) will help an investor. The data suggests this is not the case. Newsletters have a long history of making money for their authors but not their readers. In one study(2), 78% of newsletters failed to beat the market average obtained by a know-nothing investor buying a simple index fund, and that was without taking into account the cost of the newsletters or the tax consequences caused by following their advice.
Theoretically, buying stocks when valuations (i.e. Price to Earnings ratios) are high produces lower returns than buying stocks when valuations are low. Currently PE ratios are higher than the historical average. However, according to a study by Vanguard(3), PE ratios have very limited use as predictors of future stock market performance. The PE ratio only explains a small proportion of the variance of future 10 year stock market returns (0.38-0.43) and almost nothing about future 1 year stock market returns.
Real estate has been an excellent asset class for centuries. It has both desirable and undesirable characteristics when compared to traditional stocks and bonds. Perhaps the least desirable is the aspect of a second job that owning and managing it directly entails. Done well, there is good money to be made. Done poorly, especially with high amounts of leverage, it is a great way to go bankrupt quickly. Many real estate and other “hard asset” investors deride stocks, bonds, and mutual funds as “paper assets,” but in reality a stock is partial ownership in the most successful corporations this planet has ever seen. When the company makes money, you make money. Similarly, a US treasury bond is a loan to a government entity backed by its ability to tax the most successful economy in history. The reason the yields on government bonds are so low is because the risks are so low.
Investing in fine art is an inappropriate recommendation for the vast majority of investors. Fine art returns are dramatically overstated as a result of selection bias. Returns of the Blouin Art Sales Index(4) from 1960 to 2013 are just 6.3% per year, and that doesn’t include the substantial costs of insuring, protecting, transacting, and storing the art.
Gold is a reasonable, although volatile, store of value, but a poor long-term investment. It generally keeps up with inflation but does not best it. $10,000 invested in gold 200 years ago would have grown to $26,000 today. By comparison, a similar investment in bonds would have grown to $8 Million and in stocks to $5.6 Billion.(5) To make matters worse, any gains seen in precious metals or fine art are taxed at a higher “collectible” tax rate instead of the lower capital gains rates available to other investments.
A portfolio that consists of 1/3 art and 1/3 gold is both extreme and unlikely to be successful in reaching the retirement goals of most emergency physicians in anything but very unusual future economic circumstances. The theories alluded to by Dr. Woelzlein and his non-peer reviewed sources when advocating these extreme positions are neither new nor reputable.
Cryptocurrencies such as Bitcoin are highly volatile, speculative instruments inappropriate for any significant portion of the portfolio of a serious investor. It is noteworthy that on the day I wrote this response $530 Million was stolen from one of the largest Bitcoin exchanges.(6)
A moderate, low-cost, broadly diversified portfolio is the best bet for the serious physician investor to reach her financial goals. The majority of that portfolio should be invested in stocks, bonds, and real estate according to a sensible written plan that addresses the individual investor’s need, ability, and desire to take risk. Neither Dr. Woelzlein, newsletter writers, nor investing experts can predict the future with any amount of accuracy, so investors need a portfolio that is likely to be successful in as many types of future economic scenarios as possible.
1) https://pdfs.semanticscholar.org/1086/ec815c26a859df424df8d3ee52fae160c98c.pdf
2) https://www.aaii.com/journal/article/can-investment-newsletters-successfully-time-the-market-
3) https://personal.vanguard.com/pdf/s338.pdf
4) https://phys.org/news/2016-06-invest-art-fine-overestimated.html
5) https://www.joshuakennon.com/stocks-vs-bonds-vs-gold-returns-for-the-past-200-years/
6) http://money.cnn.com/2018/01/29/technology/coincheck-cryptocurrency-exchange-hack-japan/index.html