I don’t believe that we have any clients who are not interested in making money. In fact, that is why most of them come to us for counsel. However, as they say, it is possible to have too much of a good thing; and that is certainly true when it comes to viewing an account’s performance.
Some of you may say that it is not possible to make too much money. Who wouldn’t be thrilled with returns that beat the market averages by 5% a year into infinity? The sad fact is that returns are just part of the picture, and they can mask some serious risks that you may not realize you are taking.
For instance, investors will commonly compare the performance of their account to that of a stock index. Most investors do not have a 100% allocation to stocks in their account, so the comparison really tells them nothing. Comparing your account to an index is only valid if your account allocation mirrors the index.
Risk and return are different sides of the same coin. If you focus exclusively on returns, specifically eye popping returns, you are probably not paying a lot of attention to the risk that you are taking to achieve those returns. Typically, the only time that risk comes into play is when an investment is heading south. Generally speaking, return is a function of risk. In other words, there is frequently a direct relationship between the returns you achieve and the level of risk that you are assuming.
Focusing on high performance numbers is the hallmark of what we call a momentum investor. We see a lot of these types come in our doors. Their primary criteria for holding a stock is that it is going up. Not understanding what you are holding, and the risk you are assuming, can be a recipe for disaster.
Perhaps the most unfortunate side effect of performance chasing is that it can dissuade you from searching out value investors who buy undervalued stocks at bargain prices. Warren Buffett made his billions this way; it’s just a thought.
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