Are Your Expectations Leading to Disaster?

Expectations…

They can set the tone for what’s to come.

I believe high expectations are a must. They won’t always lead to fantastic outcomes. But aiming for the top is the best way I know to excel over time.

As the old saying goes…

Shoot for the moon. Even if you miss, you’ll land amongst the stars.

This is something I tell my kids all the time. And it makes perfect sense. Aiming high can take you anywhere. No one ever got far by aspiring to be average.

But can high expectations ruin your portfolio returns?

I believe they can.

You see, high expectations sometimes lead to poor decisions. They make many people quick to judge, and this blinds them to the overall picture.

I’m going to show you a danger of expectations this week. The outcomes will probably surprise you.

Compare the pair

I want you to look at two charts. Both are products of Wall Street elites. They show the performance record of their respective funds. Take a close look — I’ll have a question for you in a moment.

OK, here’s the first chart…

growth graph


Source: Bespoke Investment Group
[Click to enlarge]

This is the smoothest uptrend I’ve ever seen. It shows the growth of $1 over a period of 18 years. There’s hardly a downward blip in almost two decades. This is consistency with a capital ‘C’.

And remember, this is an actual performance history. You could have got in and out of this fund many times…and made a lot of money in the process.

Now have a look at this chart…

growth graph


Source: BigCharts
[Click to enlarge]

You’ll spot the difference instantly. The smooth, rising price of the first fund gives way to a zig-zagging climb. This performance graph looks more like a regular stock chart.

Pay attention to the scale on the right. From an opening price of $10.34, the fund finishes the 10-year period at $29.76. This is an impressive 187.8% gain — even with a few bumps.

If you’re wondering, the big fall in 2008 was due to the GFC.

OK, I’m about to ask you which manager you prefer.

But before I do, study each chart. Imagine how you’d handle the ups and downs.

Also, think about your investment expectations. Should professional managers be able to make you money all the time? The second manager clearly doesn’t do this.

Place your bets

Now let me put you on the spot. Say you were going to invest $50,000 on 1 December 2008 — near the GFC lows — which fund would you choose?

Do you have your answer?

Right, then. Here are the results as at 17 February 2017…

If you choose the second fund, your $50,000 investment is now worth $97,205. That’s a compound annual growth rate of around 8%. This is a solid result — although a bit behind the market.

But what if you choose the first fund?

Well, brace for it…

Your account is worth ZERO.

One name says it all — Bernie Madoff.

The first chart was for Fairfield Sentry Limited. This was a hedge fund run by Fairfield Greenwich Group. The fund effectively directed all of its money to Madoff.

Yes, the prices on that chart were real. People were transacting off these levels for many years. But, in mid-December 2008, it all came crashing down. The fund’s performance was a mirage.

But what about the second chart?

Well, this one is the real deal. It tracks the performance of the US$957 million CGM Focus Fund.

Don’t worry if you chose Madoff — many smart people did. One individual put US$250 million into the fund just days before its collapse. An array of banks also lost millions…even billions.

The interesting question is, why do so many people prefer Madoff’s performance?

I believe the answer is simple. People want to make lots of money from the market…and many expect to do this with very little pain. Madoff gave them this fantasy.

Have another look at CGM’s chart…

CGM


Source: BigCharts
[Click to enlarge]

Four out of the 10 years are either flat or in the red. This is not pain-free investing — many people would have walked away. Patience and high expectations don’t always mix.

You may be wondering why I’m talking about the CGM Focus Fund. What makes it so special?

Well, I’ll tell you…

Focus was the ‘Best stock fund of the decade’ (in the 10 years from 2000). The Wall Street Journal says its annual growth rate was over 18%. This was almost 3% better than its closest rival.

But that’s not all. This story has a fascinating twist…

Focus’ average investor didn’t make anything near 18%. Investment research firm Morningstar calculates the actual figure was a loss of 11% annually.

That’s right. The average investor was losing money.

How can this be?

Well, have another look at the previous chart. Pay close attention to the red circles. I believe this explains why so many people lose money in the markets.

The circles show times when performance was either flat, or down. These periods are inevitable — every trader, investor, system and fund experiences them.

And do you know what? This is precisely when many people sack their manager or adviser. They invest their money when a strategy is firing, and they pull it out the moment it stalls.

CGM made a massive 80% return in 2007. Money came rushing into the fund — US$2.6 billion in fact. But when the market hit turbulence, US$750 million went for the exits.

The problem many people face is a short-term focus. They expect positive results all the time…and when a manager doesn’t deliver, they quickly jump ship.

Profitable strategies can make you a lot of money. But I believe you need to stick with them to do well. The average Focus investor didn’t do this, and it cost them 11% annually.

I’m a believer in big expectations. Setting your sights high can lead to spectacular outcomes. But, when it comes to the markets, be realistic. Make sure you look beyond short-term returns.

It also helps to remember that down periods are part of the market’s cycle. People who think they can avoid this often pay a heavy price. Madoff’s investors know this all too well.

Cheers,

Jason McIntosh,
For Markets & Money

Editor’s Note: Do you have what it takes to profit from a winning strategy? Many people don’t. They jump from advisor to advisor with unrealistic expectations. The result is often poor returns and a lot of heartache.

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Jason is a professional quantitative analyst. Before he graduated in 1991 he joined Bankers Trust — a Wall Street investment bank — to be a trader. After Bankers Trust was taken over in 1999, Jason, already financially independent, co-founded a stock market advisory and funds management business called Fat Prophets. At 37 he sold his part of that business and retired. These days, he’s a private trader and system developer. In 2014 he launched the wildly successful trading service: Quant Trader.


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