Overuse of the rear view mirror in driving would nearly guarantee a crash. Would investing based on past performance be different?
Every advisor, and every advertisement for an investment product, advises that past performance is not a guarantee of future performance. Strangely, everyone knows that and no one pays attention.
We use the past to condition our choices because it is very hard for us to ignore things that have happened. They seem more real, but say little about the reliability of the event. The past does not guarantee some other event which has not occurred can never occur. The absence of evidence is not evidence of absence. Few investors have a list of things that did not happen and use those in their decision.
We know the general shape of stock market returns. We know that over a long time they tend to be reasonably predictable. We know stock returns over a long time are higher than bond returns. We know there is not much chance of a long return higher than 12%. We also know there is not much chance of a long return below zero. We should know that the returns will not change much without huge changes in the way we do business.
Sometimes past events negate our choices for the future.
No one would use last week’s lottery numbers as the basis for buying this week’s ticket. Strangely, the odds of winning are the same with those numbers as with any other series of numbers. Using last week’s again is no worse than any other method you might have. We do not easily grasp the nature of infinitesimal probabilities.
We assume “Past performance is not an indicator of future performance” means we should expect something negative. It does not necessarily mean that.
If my business is doing badly, perhaps I would enjoy a “business reversal.” Maybe I should buy stocks that have been doing badly and rely on reversion to the mean to save me. Risk sometimes works in my favour.
As an advisor or fund manager, you have to present the possibility of change to protect yourself from lawsuits. Essentially, “We warned you so it is your own fault.” It is primarily for clients who are not paying attention.
The warning is not an absolute guarantee. Sometimes past performance is predictive.
The past helps us understand possibilities, but delivers no certainties. We can use information from the past to help narrow our thinking, but we may be wrong. The collection and weighing and combining of events from the past provide no certainty. Maybe a little edge, but again, not always. Anticipation works. Memory less so.
Investing requires a plan B for when we get it wrong. Be sure to have one. Notice it might not work either.
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. email@example.com 866-285-7772