“Buy high, sell low” – a real-world case example

The human psyche often plays pranks on us on the financial markets. We use an actual real-world case example to illustrate why the average investor only earns below-average returns and what we can learn from this.


The disposition effect…

Investors sometimes pay dearly for incurring losses, especially when they allow them to get too large and don’t pull the emergency brake in time. Because the greater the loss, the disproportionately higher the subsequent gain has to be to get back to the original acquisition price. Even though we may know this in theory, we usually act as if we were unaware of this fact. Losers are often held too long in the hope that they will stage a comeback, and in the worst case, they end up getting sold close to their low point. Profits, in contrast, tend to get taken too soon because gains make us feel good. Almost every investor has probably fallen victim to this “disposition effect” at one time or another. It’s one of the reasons why the average investor only earns below-average returns. As an analysis by Dalbar shows, over the last 20 years, the average Joe has captured less than half of the average annual return (+2.9% as opposed to +7.5%) that he would have earned simply by buying and holding the S&P 500 index.


A poor track record
Many investors make life (too) hard for themselves

Average annual return over 20 years (2001–2020)

Sources: Dalbar, Kaiser Partner Privatbank


…and other quirks

But there is at least one other reason why many investors underperform: they enter the market at the wrong time. When it comes to making a decision about buying a stock or an investment product, the mind of an investor yearns for a confirmation, which is much more likely to come when a trend is already visible on a price chart, is underpinned by narratives and is endorsed by other investors. This is why the large mass of investors often don’t jump on the train until long after it has left the station and until an (investment) idea has gone mainstream or has landed in the (boulevard) press. The hype surrounding the ARK Innovation ETF and its rollercoaster ride over the last two years provides a topical extreme case example of this stock-market psychology. This ETF, which invests in fast-growing but thus far mostly unprofitable “disruptively innovative” growth companies, posted a stellar performance in 2020 (+152.5%) in year one of the pandemic, catapulting itself and its fund manager, Catherine Woods, to fame and attracting the interest of millions of retail investors – but only after the party was largely over, i.e. after the ETF’s share price had already skyrocketed. The performance gap between the ARK Innovation ETF’s time-weighted rate of return and the money-weighted rate of return captured by the totality of the ETF’s investors (which factors in fund inflows and outflows) is thus extremely wide, amounting to almost 20 percentage points since the ETF’s inception in autumn 2014.


Mind the gap
Only few reaped the marquee return

Performance earned by investors (money-weighted) vs. performance of ARK Innovation ETF

Sources: Morningstar, Bloomberg, Kaiser Partner Privatbank


Buy high…

What went wrong here (for investors)? The reason for the big differential between the time-weighted return and the money-weighted return is simple: the strategy generated the bulk of its performance at a time when few investors were invested in it. Even in year three of its existence (2017), when the ARK Innovation ETF posted a spectacular performance for the first time with a gain of 87.4% for the year, an average of only USD 116 million was invested in the product. Two years later, in 2019, the fund’s asset volume was much higher at an average of USD 1.6 billion. However, around 90% of the ETF’s cumulative net inflows occurred during the 18 months thereafter up until the ETF’s total assets under management reached its high point to date at USD 25.5 billion in June 2021. But the real buying frenzy by investors didn’t take place until December 2020 and the weeks thereafter – after the ETF’s share price had already peaked. For all those investors who bought in (too) late, their investment in the ARK Innovation ETF is likely to have been less an innovative adventure and much more a gut-wrenching disruptive experience.


(Too) late to the party
Most investors bought (and buy) at the top

ARK Innovation ETF and monthly inflows and outflows

Sources: Morningstar, Kaiser Partner Privatbank


…sell low(?)

The ARK-ETF episode is arguably the best-known recent example of the large mass of investors’ poor timing skills, but it’s not the only one. Other high-profile themes in 2020, such as clean energy, had a similarly hard time. What can investors learn from this?

  • Triple-digit-percent price gains don’t recur. It is highly unlikely that a mutual fund or an (actively managed) ETF can earn spectacular returns year in and year out. Annual gains of 100% or more are typically only achievable by placing concentrated bets on individual stocks in the hottest sectors of the market, which potentially may be overvalued. This commonly leads to severe losses when a trend reverses and valuations pull back to more realistic levels.
  • Risk(-bearing capacity) is not irrelevant. It is impossible to earn high returns without taking correspondingly high risks. Here, too, the ARK Innovation ETF is an extreme example – the composition of the fund’s portfolio exhibits a very high risk level in practically every fundamental aspect (concentration, momentum, liquidity, valuation, financial quality). Investors who wish to jump aboard that kind of a speeding train should be aware of the associated risks.
  • “Chasing returns leads to the poorhouse.” As a general rule, it pays for investors to refrain from trying to time the market and instead to stick consistently to a chosen strategy. Whoever does that can confidently expect to outperform the “average” investor and at least keep pace with the broad market indices.
  • Satellite strategy and cost averaging effect. Those who nevertheless would like to participate in specific investment themes should play them with a smaller budget, treating them in his or her portfolio as (more) speculative satellites alongside a large, stable core of portfolio assets. Furthermore, it’s helpful to buy into a young trend as early as possible and to build out a satellite position gradually. You can profit from the cost averaging effect and outfox the investor psyche this way.


Oliver Hackel, CFA Senior Investment Strategist

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