Investor psychology: Chasing performance

Choosing from what's popular

Investors who chase performance are often drawn to popular investments. How do investments become popular? A theme or narrative emerges and it gains followers from analysts or influencers. The theme, whether it's the Nifty Fifty stocks of the 1970s, the dot-com stocks of the 1990s or the AI stocks of the 2020s, acts as a spotlight to make certain stocks appear more prominent than others. This draws investors in. Once the stocks are already popular and running hot, then more investors notice the trend and jump aboard, hoping for the strong performance to continue or even accelerate.

Following rather than anticipating

Performance chasing is about following rather than anticipating trends. Think of an example from fashion, like ripped jeans. The mindset of chasing performance is like waiting until multitudes of people are wearing distressed denim — even lawyers and CEOs — then jumping in to become "on trend". In a similar manner, investors who chase performance are not discovering or unearthing new opportunities; they’re reacting to a trend that is already well underway and might even be close to peaking.

Expecting big things

Investors may be overconfident about the prospects of a stock or their ability to choose a winner, possibly spurred on by analysts who can be just as bullish about the next big thing. The problem with overconfidence is that it can quickly turn into under-confidence. Investors who come in with high expectations may experience impatience with sideways moves and become prone to panic selling if the investment declines. Desire for gains becomes disgust at losses, only to be replaced by a desire for more gains next time around.

Chasing performance typically produces poor results, since it involves buying high and selling low. A Morningstar annual study from 2023 shows that the 10-year annualized return was 7.7% for a broad range of funds (the investment return) but only 6.0% for the average investor in those funds (the investor return) — a performance gap explained by the poor timing of investor decisions about when to buy and sell¹. If investing were a rational process, then chasing performance would be rare, since investors would try it once or twice and then stop. Yet chasing performance has not gone away², which suggests that investors are influenced by motivations other than maximizing returns. Let's explore some of these motivations.

Group participation

Buying hot stocks allows investors to be part of a group, which can feel a lot better than being a contrarian who goes against the tide of popular opinion. Being part of a group also builds on "social proof", in which the positive opinion of others acts as a signal. For example, a tourist in a new town may infer that a busy restaurant is better than an empty one. Social proof can be a powerful signal when it’s difficult or time-consuming to form an independent opinion, like when a tourist is not familiar with a town or an investor is not familiar with an industry. Being part of a group also has a protective role. If an investment works out, then the investor takes the credit; but if an investment doesn't work out, then the group gets some of the blame. This helps the investor protect their self-image.

Excitement

The analysis involved in investing, whether reviewing financial statements, listening to earnings calls or following analyst reports, is not always exciting. In contrast, chasing performance can be a thrill, not just because of large swings in the stock price but because of the reaction of fellow investors, through investor clubs, social media platforms or other groups. This also increases the motivation for investors to make bold moves, since there are no bragging rights for simple decisions, like buying and holding index funds.

Spontaneity

Many investors have played by the rules of getting an education, becoming productive workers and building their income to acquire wealth. Investors are typically reminded to protect their wealth with written investment plans and risk statements. Chasing performance can be an outlet for a bit of spontaneity, a chance for investors to set aside rules that might feel restrictive. Investors may also set aside results with "mental accounting", where the results of chasing performance are not included in the portfolio's returns, treating a dollar used to chase performance differently from another dollar in the portfolio.

Investors may reduce the temptation to chase performance by remaining self-aware and asking reflective questions about the next big thing:

Framing choices

• What risks am I not considering? Narratives about popular stocks can sometimes be "narrow-tives" that focus on relatively limited causes and effects, while risks can arise from a broad range of factors.
• What opportunities am I giving up? The spotlight that shines on popular stocks can make other stocks, industries or regions of the world much harder to notice.

Understanding trends

• How long could it take for this trend to gain traction? Think how long it took for major trends like desktop computing or online shopping to become established. Ask if you have the patience to stick around for much longer than most people expect.
• What could cause this trend to stall or reverse? This can help you think flexibly about how the trend could evolve, when many voices are calling for aggressive growth. This can also prepare you for setbacks.

Setting expectations

• What's the batting average for this type of investment? Narratives tend to make an investment into a singular opportunity. Establish distance by asking what would happen if I were to invest in lots of opportunities like this one.
• What's my batting average when I've chased performance in the past? If the return wasn’t so good, would I be okay with a similar return going forward?

Finally, investors can reflect on the behaviour that may cause or encourage them to chase performance, such as the desire for group participation, excitement and spontaneity. It's likely more simple and straightforward to pay for these experiences directly, rather than pay for them indirectly through investing.

• Chasing performance is a pattern of repeatedly buying near the top and selling near the bottom of markets, even when it doesn't work out.
• The behaviour can arise from focusing on popular themes and narratives, following rather than anticipating trends and forming overconfident expectations.
• The behaviour can be caused or encouraged through social or emotional influences, such as the desire for group participation, excitement and spontaneity.
• Chasing performance can be tempered by remaining self-aware and asking reflective questions about the next big thing. These questions can help investors frame choices, understand trends and set expectations.