Chasing Carriages and Investment Returns

I never met my great grandmother, but my grandmother always used an expression that her mother had: “Don’t run after the carriage if it’s not going to pick you up.” I cling to that expression dearly when I think of business and personal situations where I wouldn’t run or did run after something that was never going to be.

For investors, too many people run after the carriage after the carriage has long left. They do that by chasing returns. They buy investments after they have had extensive appreciation in value. Ask anyone who bought Internet investments in 2000 or real estate investments in 2006.

Unfortunately, retirement plan administrators do the same as well when adding and subtracting investment options to a participant directed plan. The Center for Retirement Research (CRR) at Boston College just did a study on plan investment lineup changes and discovered that when making changes to a 401(k) plan’s investment lineup, administrators chase returns and do not end up improving investment performance. The study looked at investment options that were added and dropped 3 years before and after the actual change was made.

Newly added funds outperformed randomly selected funds before the change was made. However, this outperformance disappeared after the fund changes were made as the added funds did worse while the dropped funds did better.

The research showed that 401(k) plan participants chase returns as well, which is no surprise since that is what most typical investors do.

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