This Sunday morning we reach the ninth in our series of investor errors. This one’s title comes from the standard Wall Street boilerplate disclaimer that is on everything investment related: “Past performance is no guarantee of future results.”

Despite its ubiquity, it is routinely ignored by investors.

Every hot mutual fund manager who is on the cover of some investing magazine, every trader who made a one shot killing, every strategist who accidentally stumbled into a lucky call: Many people chase the gurus, looking for a little magic that will make them wealthy.

Sorry, it doesn’t work that way.

Consider: The Morningstar mutual fund rating 5 star ranking attracts lots of new investors and lots fresh dollars. The primary factor in the rating is (can you believe it?) past performance. This despite a Morningstar study that found 5 star funds mostly underperform — my assumption is it’s a case of simple mean reversion.  As it turns out, the fund’s expense ratio is a much better predictor of performance (See results here).

When making any investment, make sure you are not merely chasing a hot quarter or two. Note that there are 10,000 hedge funds and 12,000 mutual funds and very few consistent managers generating sustainable, repeatable returns.

 

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Previously:
1. Excess Fees
2. Reaching for Yield
3. You Are Your Own Worst Enemy
4. Asset Allocation vs Stock Picking
5. Passive vs Active Management
6. Mutual Fund vs ETFs
7. Neglecting the Long Cycle
8. Cognitive Deficits

 

Top 10 Investor Errors
1. High Fees Are A Drag on Returns
2. Reaching for Yield
3. You (and your Behavior) Are Your Own Worst Enemy
4. Asset Allocation Matters More than Stock Picking
5. Passive vs Active Management
6. Mutual Fund vs ETFs
7. Not Understanding the Long Cycle
8. Cognitive Errors
9. Confusing Past Performance With Future Potential
10. When Paying Fees, Get What You Pay For

Category: Apprenticed Investor, Investing, Mathematics

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

8 Responses to “Top 10 Investor Errors: Past Performance vs Future Results”

  1. wally says:

    Unfortunately, past performance is also the basic way to measure risk, so when advisers tell people to decrease risk exposure, the ways of doing that are shots in the dark.

  2. Silversem says:

    I prefer to determine the risk that i take, my self. I trade cfd’s and i can set my own stoploss levels and i can choose the amount of leverage that i want. That way i keep it all in my own hands. I always exactly know what risk i take.

    Silversem
    http://www.cfd-trading-info.com

  3. rd says:

    Past performance measures are very good for evaluating index funds as they let you figure out if the funds have significant tracking errors with respect to the index they are supposed to mimic.

  4. contrabandista13 says:

    Completely off topic, however, this is the most comprehensive comment on the NFP I have read as of yet…..

    http://www.madmagazine.com/blog/2012/07/06/which-us-jobs-are-are-growing-and-which-are-shrinking

  5. larrr1 says:

    John Paulson

  6. brokrbob1 says:

    So explain to me how fund managers are different from baseball players. In MLB, the best prospects get sent up to the majors (fund managers get more money) and if they keep performing well they stay, if they “revert to the mean” they get sent down. How would you manage a big league team?

  7. faulkner says:

    I tried to find the original Nassim Nicholas Taleb’s in The Black Swan, but have settled for Daniel Kahneman’s. ‘The illusion that we understand the past fosters overconfidence in our ability to predict the future.” Or, past performance is seen in our mind’s eyes as future performance … until it isn’t. Another cognitive error that is socially supported by the industry media everywhere.

  8. Iamthe50percent says:

    Of course there is no guarantee, but ignore it at your peril. Dogs tend to stay dogs. When I find a fund that has outperformed it’s competition for decades, I’m not going to buy the loser hoping it mean reverts.

    Mean reversion itself is mathematically null. Even if you shoot 100 7′s in a row, the odds of shooting a seven are UNCHANGED. There is no mean reversion for crap shooters although many people think so. Truly random uncorrelated events are, well, uncorrelated. And I’d trust Peter Lynch with my money rather than my barber.