It’s difficult to ignore the wild changes in poll results among the Republican primary candidates.

Every few weeks there’s a new candidate capturing the media’s attention and taking the lead, only to fall back to earth after the next flavor of the month emerges to center stage.

The parallels between this roller coaster ride of a primary and that of investor behavior are noteworthy.

It’s common this time of year for investors to review their portfolios and search for what’s done best over the past year or two.  They shift their investments into these leading areas and jump ship from the positions/markets that didn’t perform as well.

The obvious result of this is buying high and selling low, the antithesis of good investor behavior, yet it is the path most followed.

Here are a few actual examples:

1) The “Best Performing” Fund

CGM’s Focus Fund (CGMFX) returned an extraordinary 18.2% annually from 2000 – 2010.

Surely every investor in this fund made phenomenal returns over this time period, right?  Not so.

Morningstar published data that measured fund returns while accounting for money flowing in and out of the fund by investors. Here’s what the data showed:

The average investor in this fund had an annual return of -11%.

That’s negative 11%, a full 29% lower than the actual return of the fund.

How is this possible?

Very simple, the data shows that in 2007 the fund returned an eye-boggling 80%.

This was accompanied by “investors” in the fund pouring an additional $2.6 billion into it.

The fund subsequently dropped 48%, which was followed by an astonishing nearly $1 billion cash outflow from the fund, likely in search of a safe-haven or the new best performing fund.

2) 20-Year Investor Performance

In a similar tale, there is an annual study comparing US market returns vs. real investor returns.

The results published in 2011 for the preceding 20 years reveal the following annual returns:

  • S&P 500:  9.14%/year
  • Equity Fund Investor Returns:  3.83%/year
  • Bond Index:  6.89%/year
  • Bond Fund Investor Returns:  1.01%/year
  • Inflation rate: 2.57%

The examples illustrate a stark reality: momentum investing, performance chasing, and panic selling lead to very disappointing long term results for investors.

Returns hardly outpaced inflation for equity investors, and in fact lost purchasing power for bond investors.

As a result, investors develop a general distrust and disdain for the markets for delivering such poor results.

In reality, it was their own behavior that did them in.

3)  Top Performing Money Managers

Still not convinced?

In a study of more than 1500 money managers analyzed over a 10-year period commencing in 2010, 600 managers were deemed ‘head of the pack’ based on their relative outperformance of their peers.

They beat their peers/benchmark on a relative basis by an average of 3%/year over this 10-year period.

Were they ahead during the entire 10-year period?

  • All had at least one 12-month period of relative underperformance
  • 85% trailed during at least one 3-year period
  • 85% had six different 3-year rolling periods of underperformance.
  • ½ trailed by 3% or more in 3 separate periods
  • ¼ trailed by 5% or more in a 3-year period
  • ¼ trailed by 15% or more in a 1-year period

Clearly, investors in these manager’s funds lost relative wealth at numerous points over the 10-year period, but only those that stuck with their given strategy actually reaped the higher long-term rewards.

The Bottom Line

Just like voters who are figuring out who to place their confidence in, the same psychology applies to investors.

As A.A. Milne said, “The third-rate mind is only happy when it is thinking with the majority. The second-rate mind is only happy when it is thinking with the minority. The first-rate mind is only happy when it is thinking.”

Those who pursue the latest leading strategy will only underperform over the long run.

Only first-rate minded investors apply thought in making financial decisions – and end up with excellent long term returns.