Mark Hulbert has an article published on the MarketWatch site relating to the folly of following investment advice from the previous year’s hottest advisor.
Consider a hypothetical model portfolio that each year followed the model that had the best return in the previous calendar year, according to the Hulbert Financial Digest. Over 21 years through this past Dec. 31, this portfolio produced a 23.0% annualized loss.
For all intents and purposes, of course, that’s a complete and total wipeout.
Don’t conclude from this that you should instead follow the previous year’s worst performers. By doing that, you would perform even worse.
Consider a hypothetical portfolio that, instead of following the investment letter portfolio with the best returns in the previous calendar year, mimicked the portfolio that was the absolute worst performer. Believe it or not, this portfolio produced an annualized loss in excess of 50%.
What accounts for these results? Risk.
The portfolios that are at the top and bottom of the one-year rankings are almost always ones that have incurred extraordinary risk. Though once in a long while lightning will strike twice, the far more certain bet is that extremely risky strategies will eventually lose big.
The mass actions of investors to pull money out of funds that performed poorly the previous year and put it in funds that had a great previous year is well documented and, even though investors should know better, they en masse continue this practice year in year out.
FJP
