Chasing Performance—it seldom works

by | Mar 24, 2015 | General

Buying or selling an investment based on last year’s performance

Over the years, numerous studies have shown that moving in and out of investments, funds, or partnerships based on recent performance nearly guarantees mediocre results. Perhaps the most famous of these studies was conducted by Fidelity Investments. They wanted to know how the average investor in the Magellan Fund performed while Peter Lynch was the manager.

Lynch produced a 29% annual return at Magellan, however, the average shareholder in that fund only earned 6% annually. How could that happen? Shareholders (as a group) routinely bought more Magellan shares after a good year and sold shares following the bad years. 

An even more dramatic example came to light this year in Berkshire Hathaway’s annual report. For the first time, Warren Buffett published not just the change in book value for each year since 1966, but also the change in value of Berkshire’s stock. Book value is a way to measure business performance, while the stock price tells us what investors thought of that performance.

So let’s go back to 1971—in that year Berkshire Hathaway stock was up 80% vs a 14% gain for the S&P 500. If based on that spectacular year, we had bought BRK in January of 1972 the table below shows what our investment experience would have been over the next few years.

In a word, sobering. At the end of 1975, our $1,000 Berkshire investment would be worth only $554 compared with $1,025 in the S&P 500. Question: would we still own the stock after year four? Honestly, would you have wanted us to?

It took another spectacular year for Berkshire stock in 1976 just to get us back to break-even with the S&P. Even with these gains, the temptation to sell at this point would have been intense—“I finally got my money back, time to get out!” 

So another question: what would we have missed in the next five years if we had sold Berkshire during this nasty and insanely volatile period outlined above? The following table shows the results.

To complete the story: Buffett’s record for the entire ten year period produced a 22.4% annual return, compared with 6% per year for the S&P 500. Practically rhymes with the Lynch/Magellan story.

Patience is a virtue in life. But even more so while investing. 

Best regards,

Daniel A. Ogden

Dock Street Asset Management, Inc. is an investment adviser registered with the U.S. Securities and Exchange Commission. You should not assume that any discussion or information contained in this letter serves as the receipt of, or as a substitute for, personalized investment advice from Dock Street Asset Management, Inc.

It is published solely for informational purposes and is not to be construed as a solicitation nor does it constitute advice, investment or otherwise.

To the extent that a reader has questions regarding the applicability of any specific issue discussed above to their individual situation, they are encouraged to consult with the professional advisor of their choosing.

A copy of our Form ADV Part II regarding our advisory services and fees is available upon request.

Our comments are an expression of opinion. While we believe our statements to be true, they always depend on the reliability of our own credible sources. Past performance is no guarantee of future returns.