Investors know that buying high and selling low isn’t a good strategy. However research shows that individual investors tend to buy after periods of strong performance (when valuations are higher and expected returns are thus lower) and sell after periods of poor performance (when valuations are lower and expected returns are thus higher). This destructive behaviour has led to investors under-performing the very funds in which they invest.
Further compounding the problem is that investors tend to have short memories. Last year's heroes often become this years dogs.
The illustration below depicts the difference between “convex” and “concave” investing behavior.
pic via www.etf.com
A pretty good predictor an investor has of future returns of a particular share is the current valuation. To estimate future real expected returns, a simple method for calculation is the earnings yield, or E/P, the inverse of the more commonly used price-to-earnings (P/E) ratio. The E/P produces an expected real return for shares over the ensuing period.
Always remember it is the "return chasers" that provide the "alpha" that hedge fund managers chalk up as their performance. Just ask yourself..."are you providing this fat to the market"?