You may have experience of a client tempted by a ‘hot tip’ or an investment that has recently out performed, but if they acted on this, they risked ‘chasing performance’ – buying high and selling low.
The latest ‘hot tip’ may seem tempting, but unless they are thoroughly researched they seldom produce the returns hoped for. You also need to be aware of the tip’s source and be sure it does not involve inside information. Also, due to the cyclical nature of the market, today’s star performer may be tomorrow’s loser and vice versa.
Past performance is in the past
Hot tips post stellar returns. The problem is that those stellar returns have already been achieved. Entering the market as an investment registers top quartile returns will often guarantee that the investor is buying high. This mistake is frequently compounded by a temptation to sell one of their lower-performing investments in the portfolio to make cash available for the new favourite. The investor is now buying high and selling low, breaking a basic rule of successful investing.
Dangers of short-termism
Changing a strategy, based on a short-term hunch or in response to a market move, can upset asset allocation, potentially decreasing the chances of long-term investment success.
You may consider explaining that the impulse to chase performance is part of human nature, but keeping to a strategy may deliver higher returns over the long term.
A sound investment approach
Instead of chasing investment performance, encourage your client to focus on the long-term investment strategy you have set in place for them.
Remind your client that a well-diversified portfolio, designed to meet their investment goals at a level of risk that they are comfortable with, is more likely to deliver long-term returns than chasing yesterday’s winners.
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About the author
Paul Bolt, our wine expert, was recently inducted as a Chevalier de Champagne and actively trades on Livex.