Posts filed under “Psychology”

Chasing Returns Has a High Cost for Investors

Chasing Returns Has a High Cost for Investors
By YiLi Chien, Senior Economist
St. Louis Fed 04/14/14

 

 

stock market

 

The investment behavior of households could be influenced by their own past experience, especially by the return performance of their portfolios.  We can see this through U.S. equity mutual fund flows being positively correlated with their past returns.  In other words, an average equity mutual fund investor tends to buy when past returns are high and sell otherwise.  This is called return-chasing behavior.

I used quarterly equity mutual fund flow and return data from the Investment Company Institute for the period 2000-2012. The figure shows two data series: equity mutual fund flows and past quarter returns.  The flow data at period t is measured as a percentage of the total value of U.S. equity mutual funds.  The return plotted at period t is the return over the previous quarter.  Clearly, equity mutual fund flows correlated positively with past return.  The correlation coefficient between the returns and flows was 0.49.

Chasing Returns

This is important because such return-chasing behavior might cost mutual fund investors.  Given that stock market returns are almost unpredictable in the short run and the return reverts to the mean (or moves back toward the average) in the long run, the tendency to buy high and sell low when exhibiting return-chasing behavior could eventually reduce part of their profits.

To assess how much return-chasing behavior costs investors, I compared the actual realized return of return-chasing behavior in our sample to a simple buy-and-hold investment strategy (a strategy in which investors simply buy equity and hold it for an extended period of time).  We set the holding period of the buy-and-hold strategy to five years.  (The result would be even stronger if the holding period was longer.)

Return-chasing behavior involves the size of investors’ equity positions changing over time, so the returns of both investment behaviors were evaluated in terms of so-called asset-weighted return.  Note that the asset-weighted return of the buy-and-hold strategy simply equaled the time-weighted return during the holding period, which is the standard definition of average equity return reported on financial statements.

The result shows that return-chasing behavior had a significant impact on the performance of return.  The buy-and-hold strategy earned an average annual return of 5.6 percent in the sample period, while return-chasing behavior only realized 3.6 percent.  In other words, chasing returns caused the average U.S. mutual fund investor to miss around 2 percent return per year, which is very significant.

Category: Investing, Psychology, Think Tank

Why is 2014 Soft? Consider These Bear Market Excuses

Last week, we discussed why investors conflate various rationales when confronted with unknown stock market moves. As stated in “What’s Your Stock Market Story?,” people much prefer a narrative to any admission that market movements are often random. We know little, understand less and hate to admit it most of all. That column generated more…Read More

Category: Investing, Markets, Psychology

On Investing: Jonathan Clements and Jason Zweig

The Wall Street Journal’s two top personal finance journalists, Jonathan Clements and Jason Zweig, both now at The Wall Street Journal tackle the three greatest financial challenges facing Americans.

Category: Investing, Psychology, Video

The Clues to a Great Story

Source: Imgur Hat tip TED and Super Interessante

Category: Books, Digital Media, Psychology, Weekend

Stop Looking for “the Story” Why Markets Are Falling

Whenever we see any sort of disruption in markets an explanation usually follows. The headlines will explain that “Markets are going up/down because of this good/bad thing.” News anchors will solemnly intone why the volatility is significant and what it means for one thing or another. None of these casual explanations can withstand close examination….Read More

Category: Apprenticed Investor, Investing, Psychology

The Daily Routines of Famous Artists and Scholars

Source: Twisted Sifter

Category: Digital Media, Psychology

Game Theory for Bulls & Bears

“Capitulation” is the term used to define a selling climax that often marks the bottom of a bear market. It translates into “surrender” — giving in to the overwhelming need to just make the pain stop. Retail brokers tell tales of individuals bailing out, often saying things like, “Just sell, get me out, please make…Read More

Category: Cycles, Investing, Psychology, Rules, Trading

Crash!

“Markets crash all the time. You should, at minimum, expect stocks to fall at least 10% once a year, 20% once every few years, 30% or more once or twice a decade, and 50% or more once or twice during your lifetime. Those who don’t understand this will eventually learn it the hard way.” -Morgan…Read More

Category: Markets, Psychology

Irrational Non-Exuberance

The endless chatter of bubbles and crashes continues unabated. Eventually, all bull markets come to an end, and this one must eventually as well. But as I sit down to write this, the Standard & Poor’s 500 Index yesterday hit yet another all-time high. U.S. markets continue to have good internals, strong breadth and broad…Read More

Category: Investing, IPOs, Markets, Psychology

Visual storytelling

The presentation offers standard and interlinked visual charts to help authors generate story ideas and write them with consistency and reliability. I hope that these charts shall help authors to do more unswerving writing with fewer efforts. Readers are invited to comment, add slides and criticize so as to upgrade the presentation. Visual storytelling from…Read More

Category: Digital Media, Psychology