I was just reading through Vanguard’s “Portfolio Construction for Taxable Investors” when I ran across a bit of data that underscores the old saw about past performance off the stock market not predicting future returns…
In short, they provided U.S. equity data from 1985-2005 that showed that less than half of all mutual funds that ranked in the top quartile (i.e., the top 25%) in a given three year period ranked in the top 50% of funds in the next 3 year period. In other words, recent “overperformers” stand a better than even chance of underperforming the market as a whole in the near future.
While there are some problems with these data, not the least of which is a good bit of survivorship bias (i.e., a disproportionate number of underperforming funds find themselves in the “missing” category going forward), they still highlight an important lesson…
Don’t go chasing yesterday’s winners in hopes of turning a quick buck.
Just to add another voice to debate, William Bernstein, author of “The Four Pillars of Investing, ” has used similar logic to argue that:
“…high previous returns usually presage low future returns, and low past returns usually mean high future returns.”
Yes it’s an amazing world of Asset Management wherein you are not held guilty even if you perform badly going forward and yet you get paid for managing someone’s money.
http://www.my2dimes.com/
Nitin @ My 2dimes
Ah, yes. I missed the connection between Ria’s and KC’s comments. I’m with Ria on this one.
Nickel:
You may not have suggested it, but KC certainly did…
Ria: I agree, and I didn’t mean for my closing line to suggest that people should try to time the market. Rather, I was contrasting that with the inevitable outcome of chasing hot fund performance, which typically results in buying high and selling low. The exact opposite of what you want.
The “buy low and sell high” mantra is heard across the internet investment boards almost universally, but it is in practice often just a form of market-timing, and market-timing is frowned upon by many financial professionals when used by individual (as opposed to institutional) investors.
No doubt investors of equities want their shares to increase in worth, and the planned, periodic purchases of additional equities/fund-shares during the accumulation phase of acquisition is the consensus opinion of many of the most respected personal finance writers on how to go about building your investment portfolio.
That’s why most investors will be better off investing in index funds and get “average” performance.
Most investment strategies out there are not good for the long term. They work for several years, then stop working untill everyone gives up on them. Think about Dogs of the Dow. It “worked” till the 1990’s and then it underperformed the market..
At one point a few years ago I had a revelation with “buy low, sell high”. It seems so obvious, but the point is to take good strong companies (probably everyday names) and buy them when their prices are low. Then sell them when prices are high. You can always buy them back again when they dip. So simple, yet so hard to get through my thick skull. I’ve applied this principle to several stocks – buying, selling, re-buying and re-selling several times. Never underestimate the simple phrase “buy low, sell high”
This cannot be emphasized enough.
Just last week I had a big debate with a ‘financial advisor’ who berated index funds, saying managed funds outperform, and that his firm ‘screens’ for underperforming managers.
Performance chasing is the best known way to lose money.
I find it interesting that I hear more people talk about the past returns of funds rather than what it is exactly that the fund is invested in. Just the other day a co-worker told me that he was looking into a fund that a friend recommended that has averaged about 14%. No idea what the fund invested in.
Funny that this should come up just now. I am 3/4 of the way through A Random Walk Down Wall Street and this point could not be any more clear.
I was also showing the Mrs. a list of fund selections available for our daughter’s 529 plan, and it’s interesting that all of these funds still list 1, 3, 5 year and since inception performance, with a * that points you below: “Past performance is not an indicator for future performance.”
This reminds of the story about how the casinos figured out that by posting the results of the last couple of dozen Roulette wheel spins they increased their profits by getting people to bet on trends that have no influence on the next roll, rather than betting on odds.