ARKK is an actively managed ETF by Cathie Wood. It primarily invests in tech companies with large growth potential. Cathie has become a Wall Street rockstar over the past two years. Why?

  • ARKK was probably the greatest equity fund in the world from 2017 to 2020.
  • Cathie has regularly predicted future returns that far exceed any historical stock market return.

ARKK’s ascent is truly incredible–after an astonishing 3-year run that saw an investment in the fund more than double, 2020 took off like a rocketship. ARKK produced a 157% return in that year alone. Had you invested $1M in 2017, you could have watched it grow to $6M over this four-year stretch.

Past Returns Do Not Guarantee Future Returns

Last year was not a good year for ARKK. The fund has lost more than 50% in the past 12 months. QQQ, which tracks the NASDAQ 100 is a good comparison for ARKK since both offer exposure to tech companies.

ARKK has severely lagged QQQ–by 65 percentage points!

To be fair, ARKK has still produced an incredible 5-year return despite the recent struggles.

Behavioral Investment Counseling

The idea of behavior playing a significant role in investing has become mainstream over the past two decades. Vanguard, Morningstar, Dalbar, and others have produced a great deal of research on this topic.

The quickest example to describe poor investor behavior is this:

  • Investment X returns 10% per year
  • Investors in investment X only made 6% per year

To be clear, this is not saying investors are lagging an index (which is a separate phenomenon). This is saying something far worse. Investors are lagging behind the literal investments in their portfolios.

Behavioral Investment Counseling History

One of the most famous examples is from the Lost Decade from 2000-2009. It was a “lost decade” because the S&P 500 produced a mostly flat return for ten years. Quick caveat: small-cap and international stocks had a far better decade than US large caps.

During the Lost Decade, the highest performing mutual fund was the CGM Focus Fund. Fortunately for this article, the CGM Focus Fund is the greatest example of investor behavior eroding investor returns ever.

  • The CGM Focus Fund produced an 18% annual return
  • The average dollar invested in the CGM Focus Fund LOST -11%/year

How could investors lose (a lot of) money in a fund that beat every other fund during that decade?

Back To ARKK

Let’s go back to ARKK’s incredible last five years. First returns:

  • 2017: 87%
  • 2018: 4%
  • 2019: 36%
  • 2020: 157%
  • Over the last 12 months: -51%

But there’s just one problem. Virtually no one was investing in ARKK during 2017. The fund had $12M prior to 2017.

Before the unbelievable return in 2020, it still had less than $1.9B. The fund didn’t cross $10B until late 2020.

As of just a few weeks ago, ARKK managed more than $54B in assets.

Similar to CGM in the 2000s: both of these statements are somehow true:

  • ARKK has produced an incredible return over the past five years.
  • Most of the investors (or dollars) in ARKK over the last five years have lost money. Many of them have lost a lot of money!

Making Yourself a Better Investor

The reason CGM investors somehow underperformed the literal fund they invested in is quite simple. It’s a behavior problem.

Investors see 50% returns in a given year and often flock to those funds. Investors see a 15% drop in the next year and they bail. Many investors buy high and sell low. 

How did you build your 401k portfolio? Did you check the market capitalization of global equities and mimic the split between large-cap, small-cap, international, and emerging markets? Did you study what parts of the market have led to higher returns over the past century? If you’re like most, probably not.

If you’re like most, you looked at the prior 3, 5, and 10-year returns. Over the past 50 years, it’s almost been clockwork to see small-cap, large-cap, and international stocks trade who has the best decade. Had you followed this normal trend (pick whoever had the best 10-year return) over a lifetime, you would have picked the worst-performing part of the stock market every decade for 50 years.

You need immutable convictions that govern your family’s portfolio. These immutable convictions must not be swayed by recent performance, current news cycles, who happens to be in office, etc. This is how you avoid behavior disasters with your money.

How Much Do Earnings Cost?

The stock market is often depicted as a nebulous casino. This is a truly ridiculous way to view it. You’re not gambling. You’re taking an ownership stake in the greatest companies in the world.

More specifically, you get to enjoy the future earnings of companies you invest in. That’s what you’re paying for when you buy a stock fund–the future earnings of all of the companies in that fund.

When part of the market has an incredible decade, future returns can be muted. Why? In 2010, the P/E ratio of the S&P 500 was really low. Today, it’s much, much higher.

Let’s use plain language: You could buy a lot of earnings for a historically good price 12 years ago. Today, you have to pay a premium to buy the same amount of earnings.

Remember: recent returns and whatever you see on the news should not govern your investments. Build a portfolio with decades (even better: generations) in mind. Then, use financial planning to lower taxes and provide for cash flow needs in the short term.