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Don't let the investing 'fast lane' fool you

25/10/2015

1 Comment

 
Picture
We've all been there: stuck in crawling, grid-locked traffic, when all of a sudden the lane next to you starts moving and the car beside you surges ahead and disappears from view....

Your first instinct is probably to work out how quickly you can get into that fast moving lane and shave minutes off your travel time. You carefully time your move so you slip into an emerging gap in the traffic, then power past the other motorists who don't possess your superior driving and anticipation skills.

Only that's not how it works.

Some time-tested research from North America
 suggests the phenomenon of identifying a 'faster lane' in traffic is generally an illusion. That is, if you see cars moving in the next lane while you are stationary, your mind will perceive that the next lane is moving faster, when in fact the average speed of both lanes is the same.

The work from the University of Toronto instead says that, while changing lanes can give you a short burst of acceleration, you won't necessarily get there any faster. A car you overtook a few minutes ago might come puttering up beside you further along the road.

With investing lane changing is akin to performance chasing. You might see certain shares or asset classes surge ahead in the performance fast lane, while the value of your investments seem stuck in first gear. A friend or colleague might have shared a winning investment that leaves you having feelings of regret.

But just like driving in congested traffic, investors who aim to time the market and make their move to beat all the other 'slow moving' investors have the odds stacked against them. Tomes of investment research show that there are no sure-fire 'fast lanes' that will deliver you to your investment destination in a shorter amount of time than if you stick to an asset allocation designed to meet your long term goals.

Consider well-reported research into the decisions of more than 3000 US institutional pension plans who fired under-performing managers and switched to higher performing managers.

Remember these are large, sophisticated investors with plenty of technical decision-making support.

Yet the research by academics Amit Goyal and Sunil Wahal published in 2008 found that following termination the fired managers actually outperformed the managers hired to replace them by 49 basis points in the first year, 88 basis points over first two years and 103 basis points over three years.

So your best bet is to focus more on your destination than your journey and take a long term view of your investments. Stay in the same lane, stick to your investment strategy, and you are likely get there in your own time.
 

And just as changing lanes can involve an element of higher risk so too can looking for a 'faster' investment option present new risks not least of all the costs that come with changes to your investments, whether it be brokerage fees, buy/sell spreads, capital gains tax, etc.
 

The more you change 'lanes' when investing, the more of these costs you incur, and the more likely you are to make a human error, miss your timing and end up in a worse position.

It doesn't matter if you're sitting in traffic or investing: sit tight, stick to your chosen lane and remember that you're not missing out on a faster course to your destination.


Source: Robin Bowerman for Vanguard Australia


1 Comment
Wahdan Arum Inawati link
24/7/2019 03:32:33 am

why institutional pension plans who fired under-performing managers and switched to higher performing managers?

Reply



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    Sean Thomas - Financial planner 

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