Chasing Returns?

Human nature being what it is, most investors will use past performance as the deciding factor for their investment choices.  So what’s the problem with that? The problem with chasing returns is that it doesn’t account for volatility. Take a look at the chart below from J.P. Morgan which shows asset class returns since 2000.  The chart shows that small cap stocks averaged 6.6%.  That sounds great, but the volatility of that asset class is 21.2%, which means that in any given year small cap stocks may rise or fall as much as 21.2%.  Now look at the asset allocation portfolio, which is a fully diversified portfolio.  The average returns for that portfolio since 2000 is 5.7%, however volatility is only higher than owning bonds or cash.  Diversification is not exciting, but nobody likes to lose money and, more often than not, a diversified portfolio has been a reliable strategy.

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