Phil Huber’s recent post, Are Active Funds Lower Risk than Passive Funds?, is worth a read. He touches on the Active vs Passive debate, and that discussion is meaningful, but the last bullet point of his closing thoughts is worth spending a few minutes thinking on. Here is the quote:
“There’s nothing wrong with pursuing an equity strategy focuses on low-volatility stocks – provided you can stick with it during the inevitable periods of under-performance. Just keep this (slightly modified) disclaimer in mind: “Past volatility is not indicative of your future results and – more importantly – your behavior””
You could substitute any type of strategy in that first sentence, the “provided you can stick with it during the inevitable periods of under-performance” is the critical point. An investment strategy’s return matters much less than the investor’s return while exposed to the strategy.
Said another way – how you get from point A to point B is crucial. The ride from one point to the next in equity markets can be a wild one. It’s those ups and downs that bring the typical investor’s cognitive issues and emotions to the forefront. Feeling the emotions of making a lot of money or losing a lot of money is one thing – acting on them is another. The most successful investors are those that can avoid acting on emotions. Investment decisions should be calculated, data driven, and supported with evidence.
If you are making investment decisions based on performance alone, you’re setting yourself up for failure. If you are making decisions on a combination of performance and an understanding of the credibility behind that performance, you are setting yourself up for success. On the other side of under-performance is the good stuff. It’s the transition period that’s difficult. Its the transition period that typically creates the gap between a strategy’s return and the investor’s return while exposed. Do what’s necessary to get through to the other side…stay on board ALL the way from point A to point B. Be the outlier, not the average when it comes to behavior gap statistics.