The Dangers of Performance Chasing

We were going to talk a little bit about performance chasing at the top of this podcast and I'm seeing a lot of it out there and I think it's just, you know, because stocks, particularly US large growth tech stocks, have done so well the last two years, right? 2023 and 2024 both had returns of like 25% a year. And so a lot of people are looking at that and I don't know how much of it's conscious and how much of it isn't and saying, oh, that's what I should invest in. I should invest in U.S. large growth tech stocks because they return 25% a year. Well, I got news for you, all right. The U.S. stock market does not return 25% a year every year. If you are thinking this is normal, I've got news for you, this is not normal. In fact, in a lot of ways, the last couple of years have felt an awful lot like the late 90s felt. Now for those of you that are in your 50s or 60s, you know this because you were investing in the late 90s when we all got excited about anything with dot com after its name and people started saying, well, shoot, I'll just, you know, have this big tech allocation in my portfolio. I'm going to invest in qqq. You know, who needs all these other things? Who needs real estate and who needs bonds and who needs small stocks and who needs international stocks? I'm just gonna invest in the stuff that does great. Well, what happens? Well, in 2000, in about March 2000 it began, it was a pretty nasty bear market, lasted 2 years plus in the overall market as the tech stocks took a tumble. But what a lot of people don't realize, especially if they're relatively young in their investing careers, they don't realize that the US Stock market as measured by something like The S&P 500 basically had no return from 2000 to 2010. Now that's a cherry picked time period that decade because obviously 2000 is when that tech bust started. And by ending it in 2010, you include the entire global financial crisis as well. But the return on S&P 500 stocks, even with dividends reinvested, was barely positive for that decade. It was not 25% a year, it rounded to 0% a year. And that is something that can and does happen relatively regularly. If you look at long term returns for the US stock market, it's about 10% a year. But that includes a number of years like the last couple of years where you're making 25 or 30% a year. And it includes years like 2008. It includes years like 2000 and 2001 and 2002. It includes episodes like what we saw in March of 2020. It includes episodes like we saw in 2022 when interest rates went up 4% in a year and both stocks and bonds got pummeled. This is not normal to get 25% on stocks every year. Now my crystal ball's cloudy. I can't tell you what stocks are gonna return in in 2025, but if I had to make a bet on what returns are going to be going forward from right now over the next 10 years compared to the last 10 years, I would expect much lower returns on US large growth stocks in the next decade than we have seen in the last decade. So I want to discourage you from performance chasing. And here's some of the ways I'm seeing people doing performance chasing. I see people abandoning what are very reasonable diversified portfolios in order to put more money into large growth tech stocks. They're leaving international stocks, they're abandoning small value stock tilts. They're saying, well, why do I need bonds anyway when stocks always go up? In the long run, I'm going to make more money with stocks. I'm just going to put it all in stocks. They're abandoning real estate. They're borrowing money to put more money into stocks. They're not paying off debt in order to have more money in stocks. This probably doesn't end well. I don't know when it ends. You know, it's hard to say whether we're now sitting in 1996 and I'm, you know, the chairman of the Fed saying this. There's a irrational exuberance in the markets or whether this is 1999 and it really is about to crash in a few months, I have no idea. But I want you to be a student of financial history. I want you to realize that trees do not grow to the sky, that your stocks will not have a 25% return every year, and that diversification is important even when it works. It's disappointing to have your diversification work. Right? I mean, if you compared your portfolio to the s and P500 last year, you probably underperformed it dramatically. My portfolio return was something like 10% last year. Right. The S&P 500 made 25%. Why did mine underperform? Well, I own small value stocks, I own real estate, I own bonds, I own international stocks, and none of those made 25% last year. So yes, I rejoice that 25% of my portfolio is invested in a Vanguard Total stock Market fund and did awesome last year. And then of course, you kick yourself that you didn't have all your money in it. Well, that's the way diversification works. And diversification matters not necessarily in years like 2024. It matters in years like 2022 years like 2020 years like 2000. Eight years like 2000. Okay. And then, you know, having all your money in US large growth stocks may not look so good, as did the last couple of years. So be careful. Don't get sucked into performance chasing. Pick a reasonable plan that you can stick with for decades and stay the course with it. You know, whether the market goes down or the market goes up. Stay the course with your plan. It was a reasonable plan when you set it up. Fund it adequately and you'll be able to reach your financial goals with it. Don't get sucked into performance chasing.

The hosts of the White Coat Investor are not licensed accountants, attorneys, or financial advisors. This podcast is for your entertainment and information only. It should not be considered professional or personalized financial advice. You should consult the appropriate professional for specific advice relating to your situation.