By Joe Allaria, CFP®
If you’ve been an investor for a while, you’ve probably experienced times where your investment strategy didn’t seem to work like you thought it would. Maybe your strategy didn’t perform as well as the Dow Jones or S&P 500, or maybe you simply unperformed your neighbor’s portfolio. Were you able to understand exactly why it didn't work? Whatever the situation, you want answers.
Here are five reasons why your investment strategy may not have performed like you thought it would:
1. Your Internal Expenses Were Too High
One of the biggest detractors of performance are high fees, which could come in the form of mutual fund fees. When speaking about mutual fund fees, many people are unaware of the internal expenses of the funds because the fees are “invisible,” meaning there is typically no line item on your statement that shows what your mutual fund fees were in a given period. (For more, see: Mutual Funds: The Costs.)
However, mutual fund fees are certainly there. They are deducted from the performance of your fund, which is money that could have been yours. Mutual funds that have higher expense ratios tend to be those that trade more actively, or more often. On the other hand, index funds are typically some of the lowest-cost funds out there. It’s possible that a fund with higher fees might have a good track record of outperforming the index, but it’s also possible that you may have paid a higher fee for an equal or lower rate of return.
However, not all fees are bad. By paying mutual fund fees, it allows you to gain broad diversification without requiring a large portfolio size. The key takeaway here - be sure to do your best to limit the fees you pay and this should help your long-term performance.
2. You Exhibited Poor Behavior
It may be a tough pill to swallow but in some cases, you may have been a main factor in your own underperformance by exhibiting poor investment behavior. What is poor investment behavior? It’s when you do the opposite of the old phrase “buy low, sell high” and you “buy high, sell low.”
Truthfully, it may have happened because you were trying to correctly time the market. In doing so, maybe you spent some time invested and some time on the sidelines. While your intentions were good, you likely missed some of the big positive days, and inevitably, you sold after experiencing some big down days.
Here’s the thing about market timing; nobody has a crystal ball. Even the most intelligent minds in the world have not found a way to consistently time the market successfully and for extended periods of time. It’s incredibly difficult, if not impossible, to do. Yet, investors continue to try to do so at the cost of their own portfolios.
3. You Didn’t Compare Apples to Apples
In my view, one of the most common reasons that investors do not realize the rate of return they were expecting is because they are not evaluating their portfolios correctly. For example, let’s imagine an investor named Bob, who has a balanced and diversified portfolio built of 60% stocks, 40% bonds. Let’s also assume that the stock and bond portions of the portfolio are built using mutual funds, which hold hundreds or thousands of individual securities. (For more, see: What Is Your Risk Tolerance?)
However, Bob tends to closely monitor and watch the Dow Jones Industrial Average. And, he is perplexed when the Dow Jones rises by over 300 points in a day and his portfolio barely moves. Or, Bob might cite something like the Dow Jones being up by 10% over the last 12 months, but his portfolio was only up 6% (hypothetically).
In this case Bob is comparing his portfolio, made up of only 60% stocks, to the Dow Jones, which is made up of 100% stocks. Bob doesn’t realize that his portfolio is broadly diversified in stocks representing all parts of the world, while the Dow Jones Industrial Average is made up of only 30 U.S. stocks. Had Bob’s portfolio been invested in 100% U.S. stocks, his comparison to the Dow Jones would be more accurate. But with a 60/40 mix, he’s just not comparing apples to apples. If you feel your investment strategy didn’t work, it’s possible you’ve unknowingly made a similar faux pas.
4. Your Expectations Were Unrealistic
Let’s look at another example of a common error in evaluation and again consider our friend Bob. Bob’s risk tolerance allows for a maximum stock allocation of 60%, meaning that 40% of his portfolio is invested in bonds. Bob feels okay about that because he has reviewed decades of performance research and has seen how well 60/40 portfolios have done. He expects to see similar returns over the next few decades.
However, Bob has failed to consider the current market environment, namely interest rates, and how the interest rate environment is different than it was for the last 30-40 years. From the early 80s until about 2016, interest rates experienced a long-term, decreasing trend. The long-term fall in interest rates had a positive effect on bond prices and performance, causing bond returns to be favorable over that time period.
However, given today’s low interest rates, it’s difficult to see how similar returns could even be possible when using the same bond strategy that worked well for that last 35 years. In this case, Bob is expecting the past to repeat itself without understanding what generated those past returns. Because of that, his expectations are just unrealistic.
5. You Didn’t Give It Enough Time
Okay, so you’ve kept expenses low, you haven’t tried to time the market, you’ve been comparing apples to apples, and you’ve tempered your expectations. But it still doesn’t look like your investment strategy has worked. The final evaluation miscue that can occur is that investors simply do not give their investments enough time to “work.” We live in a world of immediate gratification and short-term expectations.
However, that just doesn’t work when you’re evaluating your investment into a stock or series of stocks or funds. Investing successfully in the stock market takes time and lots of time. Looking at a strategy’s results after only three months, 12 months, or even a couple years, may not give you enough data to evaluate whether or not it’s a good long-term approach. Although it’s difficult, you need to ask yourself: “What is truly a fair amount of time to evaluate the performance in this strategy?” Then, make a decision to be disciplined and stick to the plan for that period of time before considering any major changes.
Evaluate Portfolio and Process
You should consistently evaluate your portfolio and the process for making your investment decisions. It’s also important to apply prudent investment principles during this process. Sometimes, things will turn out better than you anticipated. Other times, you may have to stick it out during a recession. Ultimately, be sure you are evaluating your investments properly so that you truly know if your strategy has worked or failed. (For more from this author, see: Avoid These Portfolio Diversification Mistakes.)
Disclosure: CarsonAllaria Wealth Management does not give tax or legal advice. Please seek tax and legal advice from either a qualified tax specialist or an attorney. All articles and posts are provided by CarsonAllaria Wealth Management (CAWM or firm) for informational purposes only. By accessing or otherwise using this Article, you agree to be bound by the terms and conditions set forth below. Investing involves the risk of loss and investors should be prepared to bear potential losses. Past performance may not be indicative of future results and may have been impacted by events and economic conditions that will not prevail in the future. Therefore, it should not be assumed that future performance of any specific security, investment product or investment strategy referenced in the Article, either directly or indirectly, will be profitable or equal to the corresponding indicated performance level(s). No portion of the Article shall be construed as a solicitation to buy or sell any specific security or investment product or to engage in any particular investment strategy. In addition, this Article shall not constitute the provision of personalized investment, tax or legal advice, and investors shall not assume this Article serves as a substitute for personalized individual advice. Information contained in this Article may have been derived from third-party sources that CAWM believes to be reliable; however CAWM does not control such information and does not guarantee the accuracy or timeliness of such information and disclaims all liability for damages resulting from such sources. Links or references to third-party websites are provided as a convenience and do not constitute an endorsement by CAWM, and the Firm is not responsible for the content of any such websites. Any reference to a market index is included for illustrative purposes only, as it is not possible to directly invest in an index. Indices are unmanaged, hypothetical vehicles that serve as market indicators and do not account for the deduction of management fees or transaction costs generally associated with investable products, which otherwise have the effect of reducing the performance of an actual investment portfolio.
This article was originally published on Investopedia.