Potential for Taking on More Risk
Short-term outlooks may encourage investors to take on more risk as they seek out yield or returns in hot sectors or trendy momentum picks. As a result, they take on more risk than they might want to or understand—a fact demonstrated by lower and lower credit qualities seeping into client portfolios.
In a low-yield world, return chasing may lead to overweighting to equities. Over the last 50 years, the S&P 500 Index averaged 9% return per year. However, after a lengthy bull market (the second longest in history based on daily total returns), the S&P 500 Index now has a trailing 10-year average annual return of over 13%. Investors may now begin to expect or even demand similar equity returns going forward.
Highlighting a good quarter or year doesn’t necessarily illuminate how well a fund manager performed over meaningful periods of time or how they will perform going forward. Looking at monthly, quarterly, or even yearly trailing returns is like sprinting a marathon. It will get you to the next milestone quickly but is that a sustainable way for running a long distance?
Following the Market on the Way Up and the Way Down
By extension, investors checking their account balances every day, month, or quarter may result in potentially detrimental short-term changes as they compare short-term performance to the S&P 500 or other indices. Adjusting portfolios to mimic strategies or investments with strong recent returns or to match indices may result in the portfolio behaving too much like those investments when large sell-offs occur.
It may also encourage investors to lose sight of the long road ahead and the endurance necessary to stick to their financial plans.
Furthermore, a shorter-term performance focus not only fails to determine where investors are headed or what steps they need to take to get there, but rarely provides the recipe for success. Market-timing strategies that rely upon being right about a wide range of inputs and getting the timing right regarding entry and exit of a host of investments over and over again have a low probability of sustainable success. Few can successfully time the market over 1-5 years, and even fewer can do this over 10 years or more.
Ultimately, it’s not about beating the market and looking like this year’s hero. Investors face significant challenges that require solutions with horizons beyond the next quarterly or annual meeting. This is a big opportunity for financial advisors to help their clients successfully navigate these challenges.