Performance Chasing: Past Results Do Not Predict Future Performance
In all investments, from mutual funds to stocks to currencies, there is a tendency to engage in what is known as “performance chasing.” This is basically when you invest (often heavily) in some vehicle because its recent performance has been good. It is very important to realize that a savvy investor does not rely solely on how well something has been doing to make an investment that could affect his or her future finances. Indeed, The Oblivious Investor makes this excellent observation about why performance chasing is a bad idea:
Historically, a period of above-market performance for a given fund will be followed (eventually) by a period of below-market performance. In statistical lingo, this is referred to as “regression (or reversion) to the mean.”
Many investors make the mistake of thinking that a fund with a great track record over the last year, 3 years, or 5 years, is a “good fund.” So they invest heavily in the fund precisely when its risk of underperformance is highest (that is, immediately after a period of consistent overperformance).
Instead of looking at past performance, consider other factors:
- Costs.
- Financial stability of the investment.
- Underlying fundamental issues.
- Potential for future growth.
- Staying power.
There are many opportunities right now to get into investments that may not have performed that well recently (that’s nearly everything, though). Bargains are widely available right now, and it may be a good time to buy. If you choose carefully, you could find yourself hitched to a rising star in the stock market. Just make sure you sell before things get too out of hand.
Disclaimer: I am not an investment professional. Nothing in this piece or on this Web site should be construed as investment advice. Before making investment decisions, do your own research and/or consult with an investment professional. All investment comes with the risk of loss. You are responsible for your own investment decisions and any loss that may result from your decisions.
