Skiing can be fun, but heading downhill is no fun for investors. So, why do so many of them do it anyway? The following chart shows how performance chasing can turn into investor skiing.
Most investments are volatile, which means they go up and down. Whenever an investment like a mutual fund is at its peak, it has a great recent track record and is considered “hot”. The blue fund above jumped from $25 to $39 in only 3 months. It doesn’t get much hotter than this.
Our skier poured $39,000 into 1000 units of the hot blue fund, but the party was over by then. He rode it down to $23.50 by April. But, fear not! A new hero has emerged. The red fund doubled in only 3 months. The skier switched to the hot red fund at exactly the wrong time and rode that down to $12. A final switch to the high-flying green fund in July gave disastrous result, too.
By October, our skier had only $3000 left. So much for hot funds. This is an extreme example, but it illustrates what happens to those who repeatedly jump to the latest fund with good recent returns.
Does this mean we should look for funds with poor recent returns? Nope. It’s better to get out of the fund-skiing game altogether and learn about diversified low-cost investing strategies.