Being an advisor, I get an opportunity to evaluate several investor portfolios. Almost every time, my observation is the same. The portfolio selection is driven by one single parameter – best past performance.
This is the single guideline that, most probably, drives your investment decisions too. Whether you invest in stocks, mutual funds, gold, commodities, real estate or for that matter, to buy insurance (yes, some people still do invest in insurance), this is the one thing to look for.
You want to invest in the one that offers the best returns, maximum returns.
It almost turns into a chase. You keep switching your mutual funds from one to another because the other one has delivered far better returns.
And why not? You too want to get the best returns on your investments.
But hello! Those are past returns. The past is gone. It is not going to come back.
I am going to tell you the truth. Chasing the best or maximum returns is the biggest investment mistake you can ever make.
Why chasing returns can be your biggest investment mistake
Return on any investment is a result of:
- The nature of the investment itself – gold, stocks, real estate, bonds, etc.
- The risk associated with that particular investment
- Costs of the investment (storage, transaction, advisory, etc.)
- The time period for which you invest
- Several other external factors (world events, economic cycles, terrorists, wars, etc.)
Based on these factors, the returns can vary widely for various investment types. Of course, the riskier stocks have the potential deliver higher returns compared to the relatively safe bank fixed deposits or bonds. That’s their nature. If you understand this nature, you can use each investment type to serve a goal you have in mind.
But when your only focus is to chase returns, you can expose your investments to several risks. Let us look at them:
# 1 is the risk of market timing.
By the time you realise that a particular investment option is doing better, it may have already peaked on its performance. At that point, there is little upside benefit available to you.
Typically most investors in the stock markets tend to invest when markets have peaked. You may get attracted to stories of others making big profits. But when you invest, all that you are doing is to help those who invested before to convert their paper profits into actual cash.
# 2 is the risk of performance.
You believe that your latest investment choice is going to continue with its winning streak into the future too. Now, the past is a good gauge of the character of an investment but it is NO guarantee that it will continue to deliver similar returns into the future as well. Several factors could affect the investment’s performance.
For a quick check, look at mutual funds. How many mutual funds have consistently been top performers? Take a guess! You would realise that the charts change almost on a monthly basis.
What about Gold? Real Estate?
# 3 is the risk of higher transaction costs.
In the effort to chase returns, you are doing several transactions – constant buying and selling so that you can keep up with the best. Every transaction results in costs, such as brokerage, taxes, etc. Multiple transactions mean multiple costs. Cumulatively, each of these costs can eat significantly into your investment pie and reduce the size of your investment corpus. Not your aim, right?
# 4 is the risk of biased decision making.
In the investment world, there are several biases that tend to cripple our decision making capability. Not just yours but some of the best investors in the world fall prey to these biases. This includes the belief in one’s ability to predict market direction. It is a favourite game for most experts on TV and they fail ruefully in this adventure.
Then there is the bias that results from confidence or overconfidence because of some early wins. It fools you into making moves that can potentially wipe out all your wealth.
You may start to hear information that confirms what you believe in and filter out anything that suggests otherwise. This bias may lead you to hold onto your dud investments even though you should be selling them off immediately and cut your losses.
# 5 is the risk of not meeting your goals.
Now, this one needs attention. Money by itself means nothing. Its value lies in being able to help you meet your goals.
Let’s say you want to buy a house in about a year. You would like to park you money for the time being (better to earn some returns than just let it be idle). When you are chasing returns, you will invest it in the best returns investment idea. Most likely that will be stocks or equity mutual funds.
Now what happens if the stock market goes down dramatically, as it typically does in very short periods of time? You would not have enough money for the down payment of the house you want to buy. Is that what you were planning for? You get the idea, right?
Returns on your Investments are a means not the end
The purpose of returns on your investments is to help you meet your goals. The returns is NOT the goal.
Being able to purchase the house would give you far more satisfaction then just chasing returns.
What would be best returns for you?
In one simple sentence, the returns that will help you achieve your goals without taking away your sleep at night.
Goals such as buy your dream house or car, go on that long cherished vacation abroad, and retire early so that you can do all that you always wanted to do.
So, avoid the biggest investment mistake. Don’t chase returns! Chase your goals!
Read more: How much returns should you expect?
Have your investment decisions been affected by the lure of returns? What lesson would you like to share with others?