Is It Safe To Base Investment Decisions On Historic Information?

What can history tell us?  Quite a lot that helps if we are careful and quite a lot that is wrong if we are not.  It depends on the quality of the information.  Many people use historic information to inform their investment decisions.  That can be treacherous.

People tend to look at industry wide or category wide average returns and historic volatility.  Does that help? Maybe, but not unless they adjust for “Survivor Bias”  If the average rate of return for all large capital equity funds is 7% for the past five years, should I not adjust for all the funds of that type that have disappeared during the period.  If I did, assuming I could, would I get a different answer?  Maybe.

Would “End Point Bias” matter?  I could have a terrific return over the past 8 years if I had sold everything in early 2008  and bought back in mid march 2009.  My amazing rate of return exists solely because of timing.  It paints a case for the brilliance of my management, but is so dependent on the beginning of the period that it can say nothing about my management in other situations. 

Hedge funds generally show very high returns.  I have learned recently that some of the numbers in their averages were generated by Long Term Capital Management.  LTCM failed spectacularly in 1998.  They averaged 32% net per annum to investors up to year end October 1997, but their 1998 result is not included. Presumably because the fund was liquidated.  The 1998 loss was just under 92%.

Spin matters too.  Notice what is missing as well as what is presented.  Suppose Usain Bolt and I engage in a 100 meter race.  While this was once my specialty, I may not win.  But, if I write the press release, the headline will be, “Shaughnessy finishes second in 100 meter race, Bolt second last.” true but unhelpful. 

Know the provider.  A stock analyst may be perfectly objective or acting as a shill for the company.  Know which.

Numbers and opinion cannot replace common sense.  We must use numbers to give us ideas about where to look next but we must not rely on them as being sacred or predictive.

Evidence is always weak. My late friend and neighbour Alex Wright was a police officer and a lover of history.  He took little of what he read at face value.  Why?  “Because I have listened to two eye witnesses describe a single traffic accident.  Their observations usually did not agree on much.  Not even the color of the cars or the direction they were traveling.  It has to be harder than that to describe the reasons for a war.”

A little skepticism goes a long way.  Use it wisely.

Don Shaughnessy arranges life insurance for people who understand the value of a life insured estate. He can be reached at The Protectors Group, a large insurance, employee benefits, and investment agency in Peterborough, Ontario.  In previous careers, he has been a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.

Please be in touch if I can help you.  don@moneyfyi.com  866-285-7772

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