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Real Life: Investors follow the mythical hot hand

hot-hand

Details from the investment newsletter business on how investors fall prey to the hot-hand:

If we have a good month, we get a flood of new subscribers. If we have a mediocre month, we get a mass exodus. I’m not talking the gentle ebb and flow of the ocean tides …our subscription business is always either a monsoon flood or a scorched desert.

And therein lies the problem.

The characteristics of a program that really matter: volatility, correlation, consistency of returns, etc. tend to stay fairly constant over time; last month’s returns don’t. But it’s that last bit that most subscribers seem to base their investment decisions on.

Most subscribers get in to programs too easily without understanding the nature of what they’re trading, and they get out too quickly when this month’s returns aren’t as stellar as the last. And perhaps most importantly, they don’t view a program as a component of a diversified portfolio – they treat it as a single entity and reality-be-damned, it had better make a ton of bank now.

None of this is new. These tendencies have been observed in how investors select everything from countries to asset classes to mutual funds and is why individual investors are forever buying high, selling low, and underperforming the market.

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