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?