It is rightly said that past performance is no indication of future performance. But despite these words of caution, the one practice that investors commonly follow is – (blindly) chasing performance.
A mutual fund has a great year or two, and new investors pile on the bandwagon, pumping in their savings. Then the fund’s performance slips and disappointed unit-holders leap off in chaos. Most of them lose some money. Some of them lose a lot.
While it may be tempting to buy the year’s “best mutual fund”, it may make better sense to stick with an investment plan that is well thought out and suits your investment goals.
Chasing performance is very dangerous, yet the unfortunate reality is performance sells: Take for example, emerging markets in the early 90’s, the financial boom in the mid 90’s, and technology in the late 90’s. Funds that invested in such sectors did phenomenally well during the boom but when the decline happened, it was the investor who saw his hard-earned savings crash to nothing....
A typical example of such buying occurs when a star rated fund house receives an award for its past performance, the entire herd rushes to buy the fund at its peak price. Jumping into an award winning fund and bailing out when the award goes to some other fund in the next year is not a sound investment decision.
The bottom line is everything goes in cycles. What goes up has an equal chance of coming down and what is down has an equal chance of going up. Think about this when you have the urge to buy last years winners and sell last years losers, or when you think about jumping into a star-rated fund simply because of its stars.
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