It’s human nature to believe that we can get an edge on someone else. We haggle with the car seller to get a “steal of a deal.” We spend hours figuring out our fantasy football rosters-who to draft, who to play, in hopes of winning our league. Nowhere is this tendency more prevalent than in our investing behavior. We chase that hot fund, the one that has the “5-star rating” or that had the best three-year performance. We spend countless hours chasing the past.
Vanguard compared performance chasing to a buy and hold strategy for all of the asset classes in the Morningstar style box categories. The research asserts “performance-chasing may provide a benefit if there is persistent (that is, repeated and prolonged) relative outperformance from year to year” This is also called performance persistence. In contrast buy and hold investors believe that repeated and prolonged outperformance is unlikely year to year. So, based on Vanguard’s research, which viewpoint wins?
The research was done for the 2004-2013 period for all 9 “style box” asset categories (i.e. large cap growth, mid cap neutral, small cap value, etc.). In every asset class, the buy and hold strategy beat the performance chasing strategy by earning higher nominal returns and higher risk-adjusted returns (measured by the Sharpe Ratio). Vanguard concludes “…our analysis supports the difficulty of succeeding with performance chasing strategies in general.”
Performance chasing is not only a huge waste of time; it will likely result in an investor winding up poorer than if he had followed a buy and hold strategy. Buy and hold works especially well if it is preceded by developing a well-thought out financial plan and persistently following that plan. So, “don’t just do something, stand there!”