The Secret to Long-Term Investment Success
When it comes to long-term investment success, it's our own behavior that has the biggest impact
We’ve talked a lot about the challenges this current market environment is presenting to investors. We’re seeing a convergence of multiple headwinds coming together (interest rates, inflation), along with many positives within the economy - low unemployment, record savings, and rising wages. To make matters even harder, we’re trying to make sense of data coming out of a two-year stretch that saw the world go through a global pandemic, frankly disrupting life as we know it. How much of this data can be attributed to the pandemic? Will it be long lasting? Will things be different this time? These are some of the questions clients have asked and questions I continue to ask myself on a daily basis. Trying to make sense of it all and make good decisions for your portfolio is not easy and should not be taken lightly. If you feel that way, my guess is that you are not alone.
Over the weekend I began reading Simple Wealth, Inevitable Wealth by Nick Murray. It’s a classic investing book I’ve been meaning to read for a while now. I was lucky enough to find a copy in the mail last week as a gift from my partner, Todd, who said I had to read it. That was all it took. Although I’m not even halfway through the book, a line I read last night really struck a chord with me. It was even more meaningful given the investment landscape we’re all dealing with today. In it, Murray states “Wealth isn’t primarily determined by investment performance, but by investor behavior.” It’s not meant to diminish the impact returns can have on your portfolio and what it means to reach your long-term goals, because returns are important. But having done this for over a decade, working with clients as well as managing my own portfolio, I can say without hesitation that reaching your long-term goals has way more to do with disciplined investor behavior than any returns between Fund A vs. Fund B. Let me explain with some examples.
One of my favorite charts to help paint a picture of this idea comes from JP Morgan. In their quarterly “Guides to the Market” report, they show returns for different asset classes over the previous 20-year period. Two pieces of this chart stand out - the 60/40 portfolio allocation (light blue), and the “average investor” returns (orange). What’s important to note about the average investor is that its not speculating or saying this is the result every retail investor would get on their own. The way they measure it is with inflows and outflows of the investment funds they can gather data on. What it proves is how much emotions can interfere with sound investment principals. We’ve always been taught to “buy low, sell high” the most basic of all principals. However, based on fund inflows and outflows, what it actually shows is that most people buy high and sell low, buying into strength and selling into weakness. The returns have nothing to do with investment performance, as I’m sure many of the funds do well, but it has everything to do with investor behavior. Just like Nick Murray says in his book. Take a look at the chart below:
There’s another example from legendary investor Peter Lynch and his famous Fidelity Magellan Fund. I remember hearing about this story previously, and came across a recap from this Forbes Article. During the time period of 1977 to 1990, the fund averaged an annual return of 29%. Unfortunately, according to Fidelity, the average investor in the fund during this time had a loss on their investment in the account. How could this be possible? It’s all in our behavior. A fund like this is probably unique in that it had massive swings up and down over the time period. When the fund is doing well, investors pile in (buying high). When the fund swings back to the downside, the losses are amplified and many investors bail fearing they missed the run up. Again, behavior is everything, not the investment itself.
Let’s bring an example from today into the mix that you may be more familiar with. Take the Ark Innovation Fund (ARKK), Cathie Wood’s flagship ETF that burst onto the scene during Covid, even though it was founded back in 2014. I think that’s the perfect example to highlight - the fact that Ark had a wonderful 5-year stretch from inception to just prior to Covid (using February 17th, 2020), yet no one had heard of it. Look at the returns below:
Period from November 1st, 2014 - February 17th, 2020
Fund & Ticker Annualized Return Total Return
Ark Innovation Fund - ARKK 23.9% 211%
Invesco QQQ Trust - QQQ 18.21% 142%
SPDR S&P 500 ETF - SPY 12.32% 67%
If you thought ARKK was outperforming pre-Covid, once Covid started the fund was off to the races and Cathie Wood became a household name. Check out these returns from the peak of the market just before the Covid downturn until ARKK peaked a year later on February 16th, 2021.
Period from Feb 17th, 2020 - February 16th, 2021
Fund & Ticker 1-Year Return
Ark Innovation Fund - ARKK 166.40%
Invesco QQQ Trust - QQQ 43.97%
SPDR S&P 500 ETF - SPY 18.68%
Since ARKK’s peak on February 16th, 2021 it’s been in an absolute tailspin. The fund is down over the past 14 months just over 60%, while QQQ is up 4% and SPY is up about 15%. I don’t know what the returns are for the average investor coming into the fund, but I know the inflow / outflow pattern perfectly mirrors exactly what investors shouldn’t do. Although since inception 7 ½ years ago, the fund averages an annualized return of 17% vs. the S&P 500 returning 13%, my guess is most investors have dramatically underperformed the S&P since investing in this fund, thereby giving it the bad reputation it has today.
Take a look at these two charts from the last 3 years. I think it paints the picture perfectly of bad investor behavior. For context, ARKK was taking in $1.5 BILLION dollars of inflows per week the month leading up to its peak in 2021. In hindsight, the absolute worst time to be investing into this fund.
ARKK Inflow / Outflow - 3 years
ARKK vs. QQQ vs. SPY - 3 Years
I wish I could overlay the two charts, but I’m sure you get the picture. The peak inflows for ARKK came about the year prior to the funds peak, and the highest inflows in the months just prior to the funds top in February 2021. Most investors are either feeling the burn of the 60% fall, or sold out sometime before that. But you can see, in 2019 and prior to Covid, the fund experienced very little growth from an AUM perspective. In February 2020, the fund had $2.35 billion under management, even with the stellar track record from the prior five years, significantly outpacing the Nasdaq and S&P 500. At its peak in February 2021, the fund had just shy of $28 billion. In that year alone, it grew at an astonishing pace, both from market returns but mostly from new money inflows.
Having success in the stock market is a combination of many factors. But as we see, we are all human. Given all the challenges we are facing today, it’s hard to prevent us from chasing the latest strength, or bailing out on when a stock or index has fallen out of favor. It’s human nature, and human instinct, to make emotional decisions at the exact wrong time.
While none of us can predict the markets, and I would never recommend timing the markets, having a well thought out strategy and plan can help keep the emotions out of these bad behavioral reactions. If we can do that, we can plan for successes over the long-term. If you feel you are having trouble keeping some of the emotions at bay during this market environment, let’s plan a time to meet.