Nov 18, 2016
Why Dentists Should Avoid Chasing Past Investment Performance
Written By: Brian Hanks
Most dentists make the mistake of chasing past investment performance. How do I know? Because dentists are just like other investors, and the data overwhelmingly show that investors consistently, year-in and year-out, make the classic mistake of chasing the last hot investment trend or fund manager.
How do you decide how to invest your money?
At PFG, we have a very defined, time-tested investment process that uses history, science and Nobel-winning research. We take that process and combine it with our knowledge of our clients to come up with a strategy that — while not guaranteed — is the best available option to help their investments grow over time. We believe you should avoid chasing past investment performance.
But that’s not how most dentists do it. Not you, of course. I’m talking about those other dentists.
How do I know?
Because I see the IRA, 401k and investment account statements from dentists who ask for our help after years of under performance in their investments.
The results are sad. And it’s because their method of choosing how their money invested ignores data like the graphic below.
The graphic to the left shows how many out of a pool of 2,758 mutual funds beat the market in the 10-year period between 2001-2010.
Only 541, or 20%, did.
Not great odds.
Then, of that 541, it shows that only 37% beat the market during the next 5 years. Yikes.
Professor Burton G. Malkiel wrote in A Random Walk Down Wall Street, “I have become increasingly convinced that the past records of mutual fund managers are essentially worthless in predicting future success. The few examples of consistently superior performance occur no more frequently than can be expected by chance.”
Let me illustrate my point with an imaginary conversation happening between me and some other dentist.
See if you’ve ever seen other dentists think along these lines.
The Other Dentist: “Okay self. Nice work. You’ve saved up some money and you’ve got it in your Roth IRA (or 401k, or brokerage account, or whatever). You are handsome and wise.
Me: Yes. Wise and handsome. Don’t forget humble.
The Other Dentist: “Now, I know I need to get this money invested. Hmm…stocks are probably the right way to go. And I know buying ONE stock is silly, so I’ll go with a mutual fund. I hear mutual funds are a good way to get diversification at a pretty low cost.”
Me: Excellent! Diversification! Costs! You’re on the right track and thinking about the right things. Have you read this blog before?
The Other Dentist: “Okay, well, I’ll just browse this (magazine, website, dentaltown post, etc) list of top performing mutual funds. I’ll find the fund manager that’s the best and see if that’s a good option.”
Me: Uh oh. You’re headed onto dangerous ground. That’s not quite how it wor…
The Other Dentist: “Hey, look at this fund! 20% rate of return in 2015. It outperformed the S&P500 by 7% last year! That’s incredible. And this article says the fund is the top performing mutual fund for its category last year. I read the fund manager’s biography and he’s a freaking genius! He even went to Michigan’s for his MBA! At 20% a year, I could retire in my 40’s. Investing is easy!”
Me: No. Don’t do it!
The Other Dentist, one year from now: “The S&P500 went up 8% but my fund lost 2%. What the heck happened?”
Here’s what happened. The other dentist chased past performance. Remember the disclaimer “past performance isn’t indicative of future performance?” Well, this is what it looks like in real life.
The graphic to the left shows the ranking of 254 mutual funds over a 5 year period best to worst.
If you’re the fund manager of the one on the left, you were on the cover of magazines. If you’re the guy managing the fund on the right, you’re looking for a new job.
You would think that is because the fund managers on the left are smarter, or have a better process, or something giving them an edge.
You would be wrong.
Keeping their relative position on the chart identical, the graph below shows those exact same mutual funds for the NEXT 5-year period.
It’s totally random.
Nobel-winning research points to the fact that “beating the market” as a fund manager is indistinguishable from luck.
The winning fund managers got lucky.
An anonymous Fortune magazine writer wrote in an article in their own magazine on 4/2/99, “By day we write about ‘Six Funds to Buy NOW!’… By night, we invest in sensible index funds. Unfortunately, pro-index fund stories don’t sell magazines.”
So what do you do?
You, dear dentist, need to act like a golfer and first and foremost avoid mistakes. In golf, the tournament winner is almost always the golfer who makes the fewest mistakes. And one of the most common investing mistakes is chasing past performance. Be like golfers and first try to avoid mistakes with your investments.
It can be hard to do. There is even research showing we’re hard wired neurologically to look for past winners and choose them when making selections like investments.
Avoid chasing past investment performance.
Instead, work with an investment professional that understands the markets, and knows you personally. Work with an investment advisor who is fee-only, and not incented to sell you a product. Work with someone who has a process for educating you as the investor, keeping you engaged, and helping you avoid the common investment pitfalls as you work towards retirement. That is exactly what we do at Practice Financial Group.
There are ways of selecting investments that will provide a solid rate of return over time, while minimizing risk. We’ll continue to talk more about them here, and in other blog posts.
Give us a call anytime to find out more.
Need to have me talk to that “other dentist” in your life? Reach out anytime at firstname.lastname@example.org to discuss your investments, or anything financial in your dental life because investments are too important to get wrong.
Like what you read? Please read these other blog posts related to investing and share with your friends!
The Two Best Investments for Dentists
The Millionaire Dentist Next Door
Why Dentists Should HOPE the Market Goes Down
5 Investing Principles Every Dentist Should Know and Follow