Why Chasing Winners Rarely Works

Having a diversified portfolio can be an agonizing experience. On one hand, you will always have some exposure to the best-performing investments, but it will never be as much as you want it to be.  

For the past decade, it has been difficult to own small-cap stocks, international stocks, and value stocks. US growth stocks and REITS have been some of the best investments. But even these investments have had some terrible years.  

Source: Novel Investor

Using the data above, imagine an investor with $1,000,000, who instead of owning a diversified portfolio, just bought what did the best last year. Let’s compare them to an investor who owns a diversified portfolio that is rebalanced annually and consisting of 15% large-cap stocks, 15% international stocks, 10% small-cap stocks, 10% emerging market stocks, 10% REITs, and 40% high-grade bonds.

After the end of 2020, the investor who picks winners has about $175,000 less than the diversified portfolio that paid no attention to the market. In addition, they had substantially less risk with the worst performing year down 23% vs. 53% for the investor picking winners! 

Most investors have very little tolerance for a period of underperformance, thinking that it is wise to be watching what is doing well and investing in those areas. But it is that tolerance for underperformance in the short-term, and the ability to ignore the noise, that leads to good long-term performance. 

Thank you for reading, 

Alex 

This blog post is not advice. Please read disclaimers.