Softening the Edges of the Market

Softening the Edges of the Market

As I was sitting in traffic on my way to the office this morning, I thought of the opening scene of the movie Office Space. If you haven’t seen it, take one minute and watch the video, it’s so relatable! 

As I was watching the drivers around me weave from lane to lane, there appeared to be a very clear connection to “chasing performance” from an investment perspective.  Chasing performance is the process of making investment decisions based on what has performed well recently. 

In other words, every time we see better returns away from us (traffic moving faster) our inclination is to move to that new investment, just in time for the cycle to change.  That puts us back in the slow lane.  As we sit in the slow lane, we again see better returns away from us (traffic moving faster again) thinking this time it will be different.  Then the cycle changes again.  And round and round we go. 

It feels prudent to make the switch at the time, but that doesn’t mean that it is prudent.

From the inside, once the curtains have been pulled back, you can see that almost the entirety of the fund management industry is based around the idea of chasing performance.  Think about it – Morningstar has made an entire business out of past performance.  The star system that they advocate for is a measure of a fund’s past performance versus the other funds in their respective category.  Of course, they include the disclaimer that past performance does not guarantee future results.  How many people do you think heed that small-print advice?

Even financial advisors perpetuate this misaligned focus on the rearview mirror. When meeting with a new advisor to get a “second opinion” on your portfolio, in many cases, I’ll bet you’re offered a backward-looking 10-year Morningstar report showing you how you “would have done” if you had invested in their portfolio for the prior 10 years — as if that is somehow indicative of what you’ll get in the next 10 years. 

What do you think the likelihood is that they have held those same exact investments for the prior 10 years?  Probably not great.  This is why I put so much focus on NOT chasing performance (and why I never offer comparative portfolio analysis when working with a new prospect). 

It’s why I am clear that there will be times when diversification will look foolish and that it will be difficult to keep hanging on in faith that the cycle will come back around.  It’s why I am adamant that we focus on the evidence rather than narrative.  And by not employing active managers, we can avoid adding another potential cycle (that of the fund manager’s) to the mix.  We simply own what has historically worked.  Then we sit. 

Taking a look at a basic Callan Chart, we can see how different asset classes perform annually. 

Novel Investor Asset Class Returns Table


Looking at that chart, good luck trying to predict which sector will do well next.  While performance chasing can look irresistible at times, it seems clear to me that owning all asset classes is a more prudent approach if you are seeking more consistent long-term returns. And in retirement, softening the edges of the market can be the difference in making it and not making it financially speaking.

Thanks for reading!
Ashby Daniels

I am a Pittsburgh Financial Advisor that specializes in working with people transitioning into retirement. If you’d like more information, see Who We Serve. Or to contact me, go here.

Disclaimers: Any opinions are those of Ashby Daniels and not necessarily those of Raymond James. The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete. Expressions of opinion are as of this date and are subject to change without notice. Investing involves risk and you may incur a profit or loss regardless of strategy selected, including diversification and asset allocation

The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.
The Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index, which represent
approximately 8% of the total market capitalization of the Russell 3000 Index.
The MSCI EAFE (Europe, Australasia, and Far East) is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the United States & Canada. The EAFE consists of the country indices of 22 developed nations.
The MSCI Emerging Markets is designed to measure equity market performance in 25 emerging market indices. The index’s three largest industries are materials, energy, and banks.
The FTSE NAREIT All Equity REITs Index is a free-float adjusted, market capitalization-weighted index of U.S. Equity REITs. Constituents of the Index include all tax-qualified REITs with more than 50 percent of total assets in qualifying real estate assets other than mortgages secured by real property.
The Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market.
The Bank of America (BofA) Merrill Lynch US High Yield Master II Index measures the performance of short-term US dollar denominated below investment-grade corporate debt publicly issued in the US domestic market. Qualifying securities must have at least 18 months to final maturity at the time of issuance, at least one-year remaining term to final maturity as of the rebalancing date, a fixed-coupon and a minimum amount outstanding of $100 million. It is capitalization-weighted.
The 3 Month Treasury Bill Rate is the interest rate for investing in a government issued treasury security that has a maturity of 3 months.
Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns.

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