Overestimate, underperform

Why do people always assume that things will go on as they always have done? Apparently we can never say for sure that the sun will rise the next morning – we just think it will because it always has.

Investors seem to be applying this same reasoning to whether to buy or sell their funds – but I think the laws of fund management are far less certain. A new US paper – “Past Performance is Indicative of Future Beliefs”, by Phillip Maymin and Gregg Fisher of advisory firm Gerstein Fisher – has found that investors regularly underperform the market because they buy funds that have done well and sell ones that performed badly.

Or in other words: “Investors chase returns and in doing so create the conditions of their own demise.”

In one way, this is surprising. One of the main reasons investors often underperform is that they find it hard to sell funds that are losing money. I have no idea whether commodities will continue the spectacular falls of this week but I can guarantee someone will wish they had sold out sooner than they did.

Partly this is just pig-headedness: no one likes to admit they are on a losing streak. Vanguard, a low-cost fund manager, has done some research suggesting that inaction is the most likely path people take when they’re not sure what to do – even if failing to sell is the most stupid course of action.

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