In most fields someone who is a top performer tends to maintain excellent performance for a period of time. This is especially prevalent in the world of sports, where many all stars maintain their performance for a sustained period. Likewise this occurs in other professions, whether someone is a doctor, lawyer, or a carpenter.
In the investment world there are certainly some practitioners who are more skilled or talented than others. However, someone’s investment return relative to their peers can be highly variable on a year to year basis.
What accounts for this variability is that most investment managers tend to have a certain investment style. For example some may favor growth stocks versus value, or large versus small companies.
During 2013 the best performers in the stock market were smaller growth companies, many in the social media space. The laggards were Utilities and Real Estate Investment Trusts (REITs).
In 2014 the reverse has occurred. REITs and Utilities have increased approximately 10 percent. The Nasdaq Index, weighted with more growth companies, was down 2 percent through last Friday compared to the broad based S&P 500, which was up 2 percent. The more specialized Nasdaq Internet Index has declined 12 percent this year.
People investing in their retirement plans at work often have a variety of investment options. For many there is a tendency of going with the fund that has had the best performance in the most recent time period. However, the prior example shows that this strategy may not work out well.
Of course there are times that a fund, which performs well can maintain superior performance for several years. Therefore, I would not blindly recommend that you sell the best performing fund among your investment options to buy the one that had the poorest performance for the prior year.
What might be a more reasonable course of action would be to reallocate your percentages. For example if someone started with two stock funds of equal size, and one grew to become 60 percent, I would re balance those percentages back to 50 percent each. This strategy could also be employed to adjust someone’s mix between stocks and bonds.
Over long periods of time most investment styles produce similar rates of return. Smaller stocks have tended to do somewhat better, but that is with greater risk, which would be expected. However, over shorter time frames, like we have seen the past two years, returns can be significantly different depending upon investment style.
Where people go wrong is when they start investing in a style that has done exceedingly well for a period of time. The best example was a large inflow into overpriced tech and internet stocks in 1999 and early 2000.
What investors need to remember is that there will be times certain investment styles will do better versus others. This could be domestic versus international, or growth versus value. However, someone needs to keep a long term perspective and realize that things will average out over time.