“Past Performance Is no guarantee of future of results.” Such is the disclaimer below every performance chart produce by the financial marketplace. However, as Jason Zweig recently noted, that warning has taken on a different meaning:
“Being told that historical returns don’t ensure future success seems to make the typical investor rely on them even more. It’s as if the phrase ‘past performance is no guarantee of future results’ makes people think, ‘Well, if it’s no guarantee, then that must mean it’s just pretty close to a sure thing.’“
The more the market rises, of course, the more investors extrapolate the current trend into future returns. After all, with the Federal Reserve pumping $120 billion a month into the financial system, what will stop it from going higher? Such is why you see headlines like this:
In that article, Mark Hulbert makes the excellent point that “if” the Nasdaq continues its current pace of advance, it will double in price by 2023. Notably, while the headline will certainly get clicks, he discusses the dangers of making such an assumption. However, it represents the “psychology” of investors caught up in the heat of the moment.
The Guarantee Of Past Performance
One of the mistakes that investors repeatedly make is in the investment decision-making process. A Harvard study on the selection process by individuals of high-fee index mutual funds made an interesting observation.
“Finally, highlighting misleading long-horizon historical returns by providing the returns summary sheet caused
students to allocate more money to the fund with the highest long-horizon historical return.”
The point here is that only looking at the long-term history of any investment, a misleading assumption of potential future performance will likely get made. In other words, if the investment “X” returned “Y” annually over the last 10-years, it should do the same over the next 10-years.
What gets missed in that assumption is the difference between starting periods. For example, take a look at the chart below of the Vanguard S&P 500 Index fund. (The index is total return with dividends reinvested.)
If an investor started investing in 1987, the fund generated a 713% return over the next 13-years. Therefore, an investor would look at the performance and assume they would experience the same rate of return if they bought the fund.