The Dangers of Chasing High Returns

The Dangers of Chasing High Returns

With interest rates hovering around historic lows and no relief in sight, more investors are looking elsewhere for extra yield and higher returns on their investments. While it’s tempting to jump from one investment to another chasing the hottest investing craze or highest returns, there are real risks to this behavior.

Here are three dangers of continuously chasing higher returns from your investment portfolio.

Chasing returns can increase your risk

Investors often find themselves being lured by the promise of higher returns by switching to new investments that they might not have chosen otherwise. Unfortunately, higher returns, come with higher risks. Many of these investment alternatives will greatly increase the total risk of your portfolio and may throw your asset allocation out of whack.

In reality, most investors could earn better returns by sticking to a tried and true investing plan with a well-diversified portfolio of stocks and bonds through the market’s up and down. When markets are dragging and rates are at rock-bottom levels, some investors turn their attention to annuities, foreign denominated certificates of deposit, junk bonds, gold bullion, etc.

But no matter how bleak things look, you’re likely better off following your plan vs. rolling the dice on high returns with the next big thing.

You have missed the price movements already

Many investors have a bad habit of investing in the hottest stocks or the best performing sectors and mutual funds after they have seen their best days. We tend to pile into an investment after it has outperformed the market, and wind up chasing returns that never materialize — or worse, we buy in at the peak and ride it back down.

For example, over the past few months, mainstream investors have started to reverse course and begin putting money back into stocks. The problem is that, since the DJIA bottomed out in March 2009, it has risen dramatically. If you sat on the sidelines, you missed a huge runup. And now that the markets have rallied, you may be late to the party.

In the end, you could have saved yourself a lot of time and energy by simply riding out the market’s swings and rebalancing your portfolio as appropriate.

Chasing returns can lead to higher fees

Jumping in and out of investments can actually turn out to be quite expensive. For example, you may have to pay commissions to buy and sell stocks, and there may also be fees associated with opening/closing accounts and shifting your funds around — think early redemption fees.

You may also face costs associated with setting up accounts to trade gold, options, or commodities, or for opening things like a self-directed IRA.

On top of these expenses, buying and selling investments can have important — and costly — tax implications. There’s a reason that many investment ratings consider tax efficiency. Taxes can have a huge impact on portfolio performance.

What about you? Have you grown frustrated with paltry interest rates? Have you been tempted to chase higher yields? Or do you have a long-term mindset and an investment strategy to go with it?

3 Responses to “The Dangers of Chasing High Returns”

  1. Anonymous

    @Con-Man: Not to be too geeky, but I think you are confusing two terms. Returns are the value of stock, bond or whatever that fluctuates continually and really you are trying to predict the future. Yields are the dividend or interest on an investment. So gold or Apple stock will give you a return but no yield, where At&T, regardless of return, is paying $1.76 per share or currently a 5.7% yield.

    The reason for my desire to keep the terms straight is that yields are actually very import in long term buy-and-hold strategies, while inversely returns in short term trading strategies. I frequently chase after yields but much less interested in returns — I’m more an index mutual fund/ETF and not so much a trading type guy.

  2. Anonymous

    There are two important metrics when looking at investments, what is the expected return and what is the standard deviation of historical returns? The standard deviation is the easiest measurement of risk for an investment. Many mutual funds provide this information and you can usually find it on Google Finance. If the return you’re chasing is only a little bit higher, but the standard deviation is much higher than your normal investments, it’s not likely a risk worth taking.

  3. Anonymous

    Thank you for a post which does not justify chasing yield with being young and being able to “delay plans just a couple more years.” Dr. William Bernstein recently said, “More money has been lost reaching for yield than at the point of a gun.”

    All our money is assigned a risk tolerance and we accept whatever yield is available for that risk profile at the time. It sucks, but so does needing money you just lost in the stock market.

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