Most investors would agree with a "buy low, sell high" methodology of investing. Then why do investors consistently do the opposite and, as a result, reduce their returns? The answer is market timing. Investors feel comfortable buying mutual funds that have demonstrated a recent history of good returns. However, this usually leads the investor to "buy high" into a fund near the height of its good performance run. In fact, many studies have shown that the investor’s return would have been better if he/she would have invested in the worst asset category from the previous year.

Let’s evaluate the asset categories that experienced the largest inflows and outflows in recent years to illustrate this point.

In 1999, heading into the bear market, inflow numbers were as follows: $108.1 billion into Large Growth, $75.3 billion into Large Blend and $33.3 billion into Technology.1 Investors were buying high, however, because these categories were nearing the height of their runs, they experienced significant losses over the following three years. For example, Large Growth experienced decreased returns: 22.4%, -20.4% and -27.89% respectively from 2000-2002. In addition, Large Value and Mid Value categories had the largest outflows because investors were selling low, $34.4 billion and $10.2 billion respectively. The next year Mid Value returned on average 22.8% and Large Value returned 7%.

In 2002, heading into recovery, the top three asset categories for inflows were Intermediate Bond at $33.9 billion, Intermediate Government Bond at $29.3 Billion and Short Term Bond at $18.4 Billion.¹ Once again, this illustrates "buying high" as Intermediate Bond had returns of 9.3%, 9.8% and 8.6% from 2000-2002. The other two categories had similar returns. Guess what category experienced the largest outflows in 2002? Hint – the answer is in the preceding paragraph. Investors sold $27.5 billion (sell low) out of Large Growth before it returned 29.8% in 2003 and 6.3% in 2004. Intermediate bonds returned 6.9% and 4.1% in 2003-04.

Market research firm, Dalbar, Inc., conducted an 18-year study from 1984-2002. The study compared the average mutual fund investor return versus specific index return during the same time period. The average annualized returns are as follows:

According to the study, the average equity investor had experienced an annualized rate of return less than inflation, which averaged 3.1% annually during same time period. This seems to be the result of chasing performance as opposed to using the time tested, historically proven investment methodologies.

Studies have shown that 93% of an investor’s overall long-term rate of return is determined by his/her asset allocation. At Fragasso Financial Advisors, we will always adhere to an asset allocation, "buy and hold” methodology for our clients. However, because asset allocation models change with the economy, tactical allocations and re-balancing are necessary for proper portfolio management. Asset allocation can help you to avoid the pitfalls of chasing performance and, instead, stay the course on the journey to your financial life’s goals.