Why chasing star performers won’t guarantee investment success

While it may be tempting to choose investments based on past performance, this tactic rarely works in the long term. So, how can you put your best foot forward as an investor?

Reading about investing, you will usually find the disclaimer ‘past performance is no indicator of future performance’. While this may seem like a standard get-out clause inserted by lawyers, it serves as an important reminder that nothing is certain in the world of investment.

There is a reason we aren’t all making millions on the stock markets! Financial markets are complicated and unpredictable, with no formula you can follow to ensure you will strike big, or even get out more than you put in. It is important for private investors to carefully manage risk, as investment success often comes down to the sheer luck of being in the right place at the right time.

Given this element of chance, it is important not to get swayed by the latest trend and chase good performance. History repeatedly shows that the best performer one year could be amongst the worst the following year.

Asset class performance
There have been many examples of ‘star’ assets that have soared before dramatically crashing back to earth. The dot.com bubble famously saw US technology stocks in the Nasdaq Index rise five-fold in the late 1990s before falling 77% in 2002, wiping out billions of dollars. Just recently we have witnessed the volatile fortunes of bitcoin and other cryptocurrencies.

Essentially, there is little long-term benefit in only picking the latest top-performing asset. If you look at which asset type generated the most returns during a year, you would likely see a different star each month.

Take 2019 – the year started with North American equities on top, then the spotlight moved to UK stocks, European shares, property, Japanese equities, emerging market then Asia-Pacific stocks, and UK bonds before the year ended with cash in the lead. Over the 10-year period from 2010, one asset class rarely spent more than one month at the top and no two years followed the same pattern. Without a crystal ball or a time machine, you could not have picked the right winners every time.

Fund manager performance
The same is true of ‘star’ fund managers. While many seem to offer similar investment opportunities, the difference in performance can be significant … but often temporary.

Let’s say you had invested £10,000 in a UK-listed shares fund over the 10-year period starting January 1, 2010. If you happened to be in the best performing fund over that period, you would have made a net profit of 440%. Meanwhile, investing in the lowest performing fund would have brought a much-reduced profit of 49%. Similarly, the best-performing property fund over that period would have returned profits of 227% versus 72% from the lowest.

On the face of it, it looks like you should just pick the best performing fund. But again, choosing a previously successful fund manager is no way to guarantee ongoing top performance. Statistics illustrate how the performance of the top 25% of fund managers tends to weaken over time. Of the 56 managers in the top quarter of performers in 2015, for instance, only four remained the next year.

A sensible investment approach
So, how can you improve your chances of investment success? There are some key principles you can follow to help manage risk and reach your financial goals.

Diversification is crucial. Spreading your investments across multiple areas is the optimal strategy for minimising risk. This should include a range of different asset classes (shares, bonds, cash, property) as well as geographical regions and market sectors. Diversifying in this way gives your portfolio the chance to produce positive returns over time without being vulnerable to any single area or stock under-performing. You can diversify further using a dynamic ‘multi-manager’ approach, which reduces reliance on any one manager making the right decisions in all market conditions.

It is also important to think long term and have patience when investing. As we have seen, chasing good, quick returns rarely succeeds in the long run. Likewise, exiting a market when it dips would lock in your losses and make you miss any rebounds when markets recover. Research shows that ‘time in’ the market – staying fully invested – is a more successful strategy for investors than trying to ‘time’ the market.

Ultimately, of course, you need to make sure your portfolio is matched to your personal situation, income requirements, goals and timeline, alongside your appetite for risk. This is best assessed objectively by an experienced professional who can then build a diversified portfolio with the right balance of risk/return for your peace of mind.

For the best results, talk to a locally based adviser with cross-border experience who can bring all the principles together while ensuring your arrangements are structured as tax-efficiently as possible for your life in Portugal.

All advice received from Blevins Franks is personalised and provided in writing. This article, however, should not be construed as providing any personalised taxation or investment advice.

By Dan Henderson
|| features@algarveresident.com

Dan Henderson is a Partner of Blevins Franks in Portugal. A highly experienced financial adviser, he holds the Diploma in Financial Planning and advanced qualifications in pensions and investment planning from the Chartered Insurance Institute (CII). | www.blevinsfranks.com