Investing is a game both of mind and emotions. Successful investors will typically rely on an investment plan, whereas less experienced investors are more likely to rely on instincts or emotions, allowing poor decision making to run rampant.
With rapid gains seen in risky investments, from cryptocurrencies to meme stocks – fear of missing out, better known as Fomo, is a dominant emotion, causing many investors to chase after performance.
Simply put, performance chasing is making investment decisions based on the recent performance of an asset. That could be jumping into a hot mutual fund, picking a company stock that has had consecutive green days or blindly buying into the latest cryptocurrency or meme stock craze. Performance chasers are often trying to get outsize returns and beat the market.
It is a strategy that can result in some quick wins, whether by luck or by following market trends. But it is seen as a losing formula over the long run because a trend will inevitably reverse, and an asset may revert to its mean.
Buying an asset that has outperformed the general market means you are buying that asset at an inflated valuation – an irrational approach that generally results in poor returns, says Larry Swedroe, chief research officer at Buckingham Strategic Wealth.
“The best predictor that we have for future returns are current valuation,” he says.
Investors may make the mistake of assuming that short-term outperformance will be replicated over the longer term, such as when buying actively managed funds that have recently produced market-beating returns.
But one, two or three years is not a long enough time span to be a useful indicator of future performance, with the data showing that most actively managed funds fail to consistently outperform, Mr Swedroe says.
“Any financial economist will tell you that when it comes to risk assets, 10 years can be noise,” he says.
The flipside of performance chasing is selling assets that underperform – when, in fact, the more rational approach would be to buy. “Performance chasers often sell after periods of poor performance, which means valuations are low and expected returns are high.”
At worst, an investor can get stuck in a cycle of buying high and then selling low – always being out of sync with the market and consistently missing out on the returns on offer.
“What everyone dreams of doing is to buy low and sell high: performance chasing does exactly the reverse,” Mr Swedroe says.
But whereas performance chasing will expected to produce poor results, experts note that the motivation to buy into outperforming assets taps into basic human instincts, whether it is greed, risk aversion or the expectation that a trend will continue.
“Performance chasing is human mistake but one that we can all naturally make, based on the concept that we buy the winners and we sell the losers,” says Giorgio Medda, group co-chief executive and global head of asset management at Azimut Group.
“But within a structured, professional portfolio management approach, it proves to be always the wrong thing to do.”
For example, studies show that selling assets on the days when markets have made their biggest drops – running away from negative performance – is one of the worst decisions an investor can make, Mr Medda says. Overall, investors need to have discipline and a method to allow them to take their emotions out of their decisions, he says.
Nevertheless, for those who are guilty of performance chasing, one solace is they are not alone: there is overwhelming evidence that institutions – sophisticated investors such as pension funds – can be performance chasers too, Mr Swedroe says.
“It is not just naive retail money that chases performance and gets poor returns because of that; it is institutional investors as well,” he says.
Still, Mr Swedroe notes that there is a second type of performance chasing based on an asset’s momentum – a quantitative measure – that can reliably produce results.
But even so, this presents risks as a momentum cycle will invariably come to an end. “The problem is that most investors wait too long once they see good performance and when they do buy, it is closer to that long-term reversal,” he says.
More inducements to chase
Experts have issued a warning that the current market conditions are fertile ground for the habit of performance chasing to grow.
Many investors are seeing the large moves in the market, including cryptocurrencies and meme stocks, and want a piece of the action, says Stuart Ritchie, director of wealth advice at AES International in Dubai.
“It is often individuals who have not had much exposure to investing, but they are reading about people making unbelievable gains over very short times and people feel they are missing out,” Mr Ritchie says.
Nevertheless, even more experienced investors can fall into the trap, “because people can be motivated by greed”, resulting in them "taking on more risk than they should”, he says.
“If [experienced investors] feel like they are missing out on returns, then that can lead to a certain part of their portfolio being diverted, but we try to have conversations about what their goals are and keep them on path,” he says.
“[We ask them], ‘Do you really want to work an extra year because you gambled 5 per cent of your portfolio on Bitcoin?’”
The topic of investor experience is key as there has been a flood of new investors joining the market since the Covid-19 lockdowns began last year, with research from Charles Schwab showing that as many as 15 per cent of retail investors in the US have been in the market since 2020.
Having joined a market that has been moving steadily upwards since the March 2020 crash, investors may even be rewarded in the short term by performance chasing, says Theo Papathanasiou, chief client officer at Abu Dhabi-based financial services company ADSS.
He ticks off several factors contributing to performance chasing, including social pressures, the fact that technology has made market access easier than ever before and a growing network of free information about markets and individual assets, such as Twitter.
But the trending market is also reinforcing for investors that performance chasing works, Mr Papathanasiou says. “[There is] a positive feedback loop for new investors, with investors being rewarded for performance chasing and chasing after ever more returns.”
This can lead to them taking on higher levels of risk and erode virtues such as patience, he says.
But it also points to the obvious fact that novice investors are experiencing market conditions that are not – if history is a guide – expected to endure.
A significant drawdown in the market could provide a rude awakening for novice investors, says Mr Papathanasiou. “It is like a one-month-old baby who has been born in the summer: the only thing they know is warm weather,” he says.
The habit of performance chasing may be as old as investing itself, but it has been given a distinctly 21st century twist by the role that social media can play, with platforms such as TikTok or Instagram filled with videos of traders and influencers living lives of luxury and claiming to have made vast sums of money in the markets – seemingly with little effort.
“It has just been pumped into people's faces that investing is easy and quick,” says Mr Ritchie. “And it is not. Absolutely, it is slow. It can be simple but it is not easy."
His advice is to ignore claims of quick wealth made on social media platforms. “It is a bit like gamblers: they tell you about the wins; they never tell you about the losses.”
And while technology has made it far easier for investors to gain access to markets, some trading apps have been criticised for gamifying the investing experience.
In particular, Robinhood has been criticised for using bright colours and graphics to stimulate the brain’s reward system, which may “obscure the complexity of investing in stocks and other financial instruments behind a fun, game-like environment”, according to research.
In response, a Robinhood spokesperson shared a link to a blog post stating: “Our goal has always been to present the most relevant, useful information to our customers as clearly as possible, so that they can make informed investment decisions on their own terms>”
Research has also found that investors who began using apps on their phone to trade stocks – rather than desktop browsers – gravitated towards holding riskier assets.
“The best thing for those people is to put the phone down,” says Mr Swedroe.
The anti-chasing solutions
Experts say it is still possible to balance out the long-term approach while still participating in the excitement of the market.
“You certainly do not need to invest in anything beyond a global stock fund and global government bond fund,” says Steve Cronin, founder of DeadSimpleSaving.com. “But if you need to scratch that itch, there is nothing wrong with investing maybe 10 per cent of your stock and bond portfolio in riskier things: actively managed funds, thematic or sector funds, individual stocks, crypto.”
“This is fun money only though – I would ring-fence it from the rest of your portfolio, so losses don't affect your future.”
Nevertheless, he points out that while active investing, such as stocking picking, may produce results in the short term, “[in the long term] you will almost always underperform the overall market and waste a lot of time, energy and money while doing so”.
Most investors dream of buying low and selling high: the easiest way to achieve this is to invest in a diversified portfolio and carry out regular rebalancing, whereby the stronger performing assets are sold down, with the profits being fed into the underperforming assets, to maintain the desired portfolio mix, says Mr Swedroe.
“Rebalancing is the opposite of performance chasing, because you are selling what has done well and buying what has done poorly,” he says.
Investors need to move away from reactive or emotion-driven decision making – although Mr Ritchie says that this can be difficult for some people who are caught up in the moment.
“That is where having an adviser who is emotionally removed from a situation can be beneficial,” he says.
The simplest solution is often to not look at your investment portfolio. “Doing nothing is the right answer almost all the time – you should not be reacting to what is likely to be just noise,” Mr Swedroe says.