Q. International stocks are doing really well, so I’m thinking about investing more money into them. What do you think?
A. 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.
Performance Chasing
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.”

Performance is good. Chasing performance…not so much.
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.
A Winning Strategy: Create a Written Investment Plan
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. You can DIY your own plan if you're a hobbyist that enjoys reading and sorting through a lot of blog posts and good financial books. For those that don't have that kind of time or don't really enjoy this stuff, I've put together, Fire Your Financial Advisor! A Step By Step Guide to Creating Your Own Financial Plan. I created this course to be the cheapest and quickest way possible to get the job done. For folks that want a little more hand-holding, the best option is with the assistance of a competent, fairly priced advisor.
What do you think? Have you spent time chasing performance? What was your experience? Has a written investment plan helped you stay the course instead of selling low and buying high? Comment below!
I completely agree. This is why it is crucial to make a plan and stick to it. Some interesting studies show that the more often you check your stocks, the more likely you are to change something, and the more likely you are to lose money.
Changing on a set schedule (1-3 years) or by bands (off by 5% either way) as you have recommended in the past seems to work best. That way, you are rebalancing based on something completely outside of the market. You are not making changes based on what the market is doing.
The hard part about this is that your inner person wants to “Win” so badly! We all enjoy the feeling of saying, “Hey, I picked the winner! I saw it coming.” The problem is that most of the time, you are not going to pick the winner. Technical analysis (looking at charts) and fundamental analysis (looking at values of companies) has been shown to be difficult to impossible to perform. An entire book was written on it (A Random Walk Down Wall Street). Low-cost index fund investing wins out the majority of the time, and its the easiest to do!
It is much easier to “set and forget” into low-cost index funds into various asset classes. Then set up a schedule to rebalance. That way, you get rid of the biggest enemy to your financial success….you. Take the emotional aspect out of investing and stick to the plan.
Well said
I was just having this conversation yesterday with my Dad who is a retired pharmacist. Stocks, which have done well over the last few years, were down significantly yesterday. Whereas bonds, which have done poorly recently, were up yesterday. The only certain thing about the market is uncertainty. I like the analogy of diversification being the placement of your players all around the rink.
Asset classes and strategic evidence based tilts “playing their positions” is a great metaphor. Go Hawks!
No comments by noon? Everyone must be at the WCI conference, haha.
I literally just thought the same thing when I checked back. Haha!
And actually, I left a comment this morning but it is getting moderated for some reason.
Ah, yes, I see that now. Yes, they must have been moderated or hidden earlier. The moderator must be at the conference too, lol.
Moderator was at the conference too!
Or it’s just a boring article. But yes, many of the usual suspects were definitely at the conference!
The key is stay the course. If you do that eliminates performance chasing and most rebalancing
I did not sell in 1987, 2002 or 2008, nor have I ever rebalanced.
My present asset allocation is quite close to what it was in 2000 and 2010.
If you don’t panic sell you rarely have to rebalance………….Gordon
I think it is a risky bet for the benefit, especially in a taxable account, but if you chase returns based on a shorter time-frame AND re-balance on a shorter time-frame (i.e. the momentum effect), you seem to get some positive bonus. For example, I performed the following simple test at portfoliovisualizer.com.
Time Frame: 1997-2017
Funds: VTSMX (Vanguard Total U.S.) / VGTSX (Vanguard Total International)
Portfolio 1: 50/50 Split between U.S. and International (Re-Balanced Annually)
Portfolio 2: Start 50/50 in first year (1997), then allocate 100% to the fund that returned more in the previous year (“Chasing Returns”).
Results
Portfolio 1 CAGR: 7.00%
Portfolio 1 Ann. Volatility: 18.96%
Portfolio 1 Sharpe: 0.26
Portfolio 1 in 2008: -40.57
Portfolio 2 CAGR: 7.92%
Portfolio 2 Ann. Volatility: 19.33%
Portfolio 2 Sharpe: 0.30
Portfolio 2 in 2008: -44.10%
From a return and risk-adjusted return perspective, you earned an almost 1% premium. Not bad at all, but…
1. Will that work again in the next 21 years? Who knows…I think it probably will, but it’s a risky bet to make with any sizable portion of your retirement savings.
2. In a taxable account, you would have a LT Cap Gain Tax Drag in a number of years (9 out of 21 to be exact), reducing that “premium” by a nice chunk.
3. Behaviorally, you are introducing large tracking error to your investments…Despite what you say, most people cannot tolerate this.
So…does it work? Historically speaking, yes…
Should you try it in a tax-protected account? I would think long and hard about it before I made a sizable bet on that performance repeating itself. Most people will be better off with the 50/50 split, re-balancing, staying the course, and focusing more on saving more/boosting income.
FD: I personally have a “fun” account that runs a strategy similar in theory to this (Dual-Momentum), but it’s a very small portion of my invest-able assets for the reasons outlined above.
Rebalancing frequently would decrease the benefit of momentum. The key to momentum is to let it ride. Good studies show the ideal rebalancing interval is actually 1-3 years.
For a different view, see Kitces article, “Finding The Optimal Rebalancing Frequency – Time Horizons Vs Tolerance Bands”. In summary he concludes , “… the research suggests a superior rebalancing methodology is to allow portfolio allocations to drift slightly, and trigger a rebalancing trade only if a target threshold is reached. If the investments grow in line and the relative weightings don’t change, no rebalancing trade occurs. However, if these “rebalancing tolerance bands” are breached, the investment – and only the investment – that crosses the line, is then bought or sold to bring it back within the bands.” He acknowledges that this method “requires ongoing active monitoring of the portfolio.”
Not to get too into the weeds here…but…increasing the frequency of re-balancing periods does increase “momentum” returns. Maybe we are talking about a different definition of “momentum” (Relative Momentum for me..Your “let it ride” comment makes me think you are talking about Trend Following or “Absolute Momentum”??), but increasing re-balance periods does not help momentum returns. You can take your pick of any academic study (White papers or book) done on momentum and find that as you increase your re-balance/holding period (1 Month > Quarterly > Semi-Annually > Annually, etc.), the returns from a momentum strategy increase (Here is a good example: http://www.dualmomentum.net/2016/10/book-review-of-quantitative-momentum.html).
Now, the tricky part becomes on trying to figure out how much slippage occurs from increasing your re-balance periods. I have seen arguments made that the cost to increase turnover is not that large and gets blown out of proportion by some studies AND I have seen studies where you lose a massive chunk of the momentum premium by re-balancing frequently. The truth is, I don’t know, but from a historical perspective, increasing the re-balance/holding frequency is certainly a benefit to a momentum strategy.
Waiting 3 years to re-balance is much more in-line with a “Reversion to Mean” strategy than Momentum imo.
Here is a Portfoliovisualizer link to play with if interested:
https://www.portfoliovisualizer.com/test-market-timing-model?s=y&coreSatellite=false&timingModel=4&startYear=1996&endYear=2017&initialAmount=10000&symbols=VTSMX+VGTSX&singleAbsoluteMomentum=false&volatilityTarget=9.0&downsideVolatility=false&outOfMarketAssetType=1&movingAverageSignal=1&movingAverageType=1&multipleTimingPeriods=false&periodWeighting=2&windowSize=12&windowSizeInDays=105&movingAverageType2=1&windowSize2=10&windowSizeInDays2=105&volatilityWindowSize=0&volatilityWindowSizeInDays=0&assetsToHold=1&allocationWeights=1&riskControl=false&riskWindowSize=10&riskWindowSizeInDays=0&rebalancePeriod=1&separateSignalAsset=false&tradeExecution=0&timingPeriods%5B0%5D=5&timingUnits%5B0%5D=2&timingWeights%5B0%5D=100&timingUnits%5B1%5D=2&timingWeights%5B1%5D=0&timingUnits%5B2%5D=2&timingWeights%5B2%5D=0&timingUnits%5B3%5D=2&timingWeights%5B3%5D=0&timingUnits%5B4%5D=2&timingWeights%5B4%5D=0&volatilityPeriodUnit=1&volatilityPeriodWeight=0
Lots of definitions of momentum. No sense in having any sort of discussion about it until it is defined.
I’m familiar with the trend-following scheme known as dual momentum as discussed here:
https://www.whitecoatinvestor.com/dual-momentum-investing-a-review/