Chasing short term performance will always seem to be the only intelligent choice for the financial industry’s most valuable clients: the average market participant who wants to learn as little as possible about investing, which are the majority.
Even though everyone knows they need to buy low and sell high to make money, too many participants falls prey to psychological pressures and get lured into allocating more capital towards stocks that went up in price recently, while selling or avoiding those that went down. They seem unable to comfortably buy what’s going down and sell what’s going up. This is why it is so hard to buy low and sell high. It is as if they react through the illusion that there is a direct and reliable correlation between movements in stock price and business quality.
The truth is wherever the money flows, the short term return follows. But money won’t come your way by simply following short term returns. In the short term market movements are simply the results of an ongoing popularity contest. Over the long term however, the weight of fundamentals behind quarterly reports and logical reasoning does attract prices towards rationality.
Chasing returns means to blindly follow the majority, putting our money mindlessly on top of the biggest pile of money, even better if the pile grew faster recently. Since the pile probably never got this big before and our money is right on top, our expected returns at the moment of purchase are the lowest one between all the participants in that pile, everything else being equal. The only way to profit from the point we put our money in, is if we sell at a future point where more money has been poured in than withdrawn from the pile. Which means we hope that future capital allocation mistakes will be made as soon as possible by as much people as possible, but not by us. Time is not on our side at all because there is a deadline. And it is a problem because it’s an invisible deadline, we rely entirely on luck. In order to avoid losing almost everything, we must be the lucky one who sells at the perfect time, just before the crash. While it is never too early to sell an overvalued investment, there are huge psychological costs when selling “too early” in a speculative bubble: feeling regrets that could lead to an even worse outcome. Which could convince us into getting back in at prices that are way higher, just before it crashes.
As investors, it is much wiser to let the returns chase us by patiently assuming the risk of being too early at the party. We get in this position by focusing on buying into unpopular and cheap above average opportunities, which often means buying what’s going down. There is much more available room for other people’s intelligent capital over our own money in theses piles. Since we don't have a deadline and are betting on long term rationality instead of long term irrationality, time is on our side. We get the luxury to wait patiently for the crowd while enjoying above average yields. If the crowd arrives sooner or more a bit more excited than expected, we can always sell them our now popular spot, get paid a bonus for the popularity gained while we held the spot, and go find another unpopular and cheap spot to go and wait for them to come and join.
Skate where the puck is going to be, not where the puck is.
Be patient and let the returns chase you, instead of chasing them.
