Is it wise to follow the herd?

We are creatures of habit, aren’t we? And we are also creatures of the ‘herd’ mentality. If we do what everybody else does, we may be wrong, but we won’t be alone. When the 2008 market meltdown happened, people lost 20, 30, 40% or more of their hard-earned wealth. We were managing money in a passive way at the time and so our clients’ accounts were down as well. When we met with our clients, they were very gracious about letting us off the hook. After all, everyone was down. That’s when we decided to move to an active management style of investing for our clients. The market hit its lowest point on March 9, 2009, then started a climb that is still going on. It’s experienced three minor corrections of just over 10% in the 9 years and six months since the market started its current climb. The longest ever Bull Market is still going on. Because of that, Passive investing has way outperformed Active investing during that time. Because of the high volatility in 2009, actively managed accounts sold twice as much as passive accounts, about $300 billion to $150 billion (source: Catalyst Funds). Now that everything in the market has been bopping along with few hiccups, passive out-sold active investments $600 billion to nothing last year. Active investments have actually had net outflows for the last three years. Is that short-sighted? Well, when, not if, but when the market turns down hard, and those passive investments start hemorrhaging money, active investments may still be able to maintain all or most of their value. At least that’s what they are designed to do. When this happens, there will be lots of people who will lose 20, 30, 40% or more of their value, just like they did in 2008 and early 2009. Many will swear off the stock market forever, blaming it for taking away their financial security. My profession will also be culpable. The vast majority of us do what our clients do, we look to the recent past and project that into the future. While selling our clients passive, and very expensive, investments is legal, it’s also lazy (or incompetent) because nothing is easier that saying to your client, “Well, Mr. Client, the Gronsky Mid-Cap Value fund made 27% last year. I’m sure you want some of that, don’t you?” That’s looking at the recent past and projecting that performance forever into the future. Had the ‘advisor’ looked, he may have seen that mid-cap value investments had fallen out of favor and were now trending down. Because of that, mid-cap value would likely be losing value, not making the 27% it had made last year.

At ProVest, we look closely at the trends and try to stay out of down-trending sectors of the market. So while it may be easy to sell an investment that did well ‘last year,’ we think that once we explain how we go about investing, our clients will see that their own human nature can get them in trouble and in turn will let us help them take the steps to avoid, from now on, the big, big loss.