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The Biggest Investment Mistake I See

Probably the biggest mistake I see people make when it comes to investing is chasing returns. And to be honest, it's not hard to see why. 

When making investing decisions, we oftentimes pay attention to historical performance - and most of the information we have handy show us the Year-to-date, or 3 year, 5 year, or 10 year to date returns. This is helpful, but doesn't give us the best information because it builds in recency bias - i.e. what has done the best recently. 

Let me show an example. 
Two options: Portfolio 1, or Portfolio 2 charted over the past 5 years. Which do you choose? If this is our only information, Portfolio 1 seems like the best choice. 

But let me show you something else, same portfolios:
Whoa. That's a huge difference. The only difference is the time frame: 5 years vs 40 years. The keen reader will notice this second chart is logarithmic, (the vertical axis is scaled, not evenly spaced) and so it doesn't show the full effect. Portfolio 2 grew double the amount of Portfolio 1 (initial balance of $10k grew to $1,034,291 vs $2,255,087). 

But rather than choosing arbitrary years, I think a better way is to look at rolling periods of time. This is a little more nuanced, but it gives us better information. 

Rolling returns looks at intra-time periods within a larger time period. In the above example, 5 year rolling periods would include 1979-1984, 1980-1985, 1981-1986, etc.  This helps reduce recency bias as far as what's done the best in the X-to-date examples from above. 

So, with these two portfolios mentioned above over 40 years, we can look at the below rolling periods of time:
This doesn't graph neatly - but you can see that over every rolling time period measured, Portfolio 2 had a higher average return than Portfolio 1. If we only looked at the first data set from above - 5 years to today - we'd have chosen arguably the wrong portfolio based on growth alone. 


PS - Sorry for going over the typical 250 word count.

PPS - All data sources above from PortfolioVisualizer.

PPPS - For what it's worth - Portfolio 1 is US Large Growth Companies, one of the best (relative) recent performing asset classes among equities. Portfolio 2 is US Small Value Companies, one of the worst (relative) recent performing asset classes among equities.

 
Interesting Resources

Quote
Alchemy - Rory Sutherland (book)
"You cannot describe someone's behavior based on what you see, or what you think they see, because what determines their behavior is what they think they are seeing." 

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7 mins | CalibratingCapital
I will admit I've been somewhat sheltered from an awful truth of sexual harassment and discrimination against women in my profession. Over the past few weeks, some colleagues have been writing about this and sharing stories - and it's heart-breaking, eye-opening, and anger-inducing. After sitting on my thoughts for a few weeks, I wrote this piece challenging men, not just in our profession but in general, to do better. First, we need to listen. And then we need to look within ourselves, look around our peers, and look down to our children. 
This week I've been fighting off some type of chest cold that's had me in somewhat rough shape. And it made me realize how oftentimes when we're feeling healthy - we take it as granted and don't really appreciate it. 

What's something you're appreciative of today? Shoot me a reply - or even better, let someone else know you're appreciative of them. 

Gratefully,
Jeremy
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