The Fallacy of Past Performance Chasing (and why we have trouble convincing you otherwise)

September 15, 2021

The Fallacy of Past Performance Chasing (and why we have trouble convincing you otherwise)

 

“FEAR INCITES HUMAN ACTION FAR MORE URGENTLY THAN DOES THE IMPRESSIVE WEIGHT OF HISTORICAL EVIDENCE.” —JEREMY SIEGEL

Prominently displayed as a metaphor, I keep a large crystal ball in my office conference room. It’s a prop to teach clients to avoid the pervasive habit of assuming a rearview mirror is a crystal ball into the future.

Paraphrasing the old saying, “Man repeats himself, but history never does,” and what we also know to be true of the stock market, history truly never repeats itself exactly. Trying to convince investors otherwise is in a word, taxing. Investors appreciate cogent explanations of market movements. But as soon as the market turns volatile, those same explanations, no matter how logically presented, will not assuage those who still feel the market will continue downward.

There have been numerous studies performed on investor attitudes and behavior. One is from finance professor Meir Statman of Santa Clara University, who curated 10 years of investor surveys. The proportion of investors who expected stocks to go up over the coming six months rose, on average, by 1 percentage point with every percentage-point increase in the S&P 500’s returns for the prior month. It was clear that these investors believed that the imminent future is shaped by the recent past. (Kenneth L. Fisher & Meir Statman (2000) Investor Sentiment and Stock Returns, Financial Analysts Journal, 56:2, 16-23, DOI: 10.2469 / faj.v56.n2.2340)

Further, in a more recent study published in The Journal of Experimental Psychology, researchers tested investing disclaimers about past investment performance on US investors. In over 60 rounds, the participants chose between “Fund A” and “Fund B,” with prior knowledge of the fund’s fees and gain or loss over the previous month. With a few exceptions, generally, due to much lower fees, fund A would outperform over time.

However in spite of viewing the standard mutual-fund disclaimer that “past performance does not guarantee future results,” they more often chose the fund with higher fees. Therefore, the average investor was saying that they know better, and perhaps it WILL work for them. The researchers concluded the phrase “does not guarantee future results” may cause investors to mistakenly conclude that past performance is a highly reliable indicator, and that apparently investors do not want to settle for investing like others, rather, they simply want to get ahead!

So, as you watch the market gyrating based on the disaster du jour (or other external stimuli) and you do not listen to your advisor, or follow your own common sense, try to remember most investors acting irrationally, on either fear or greed, or buying what is popular, will most likely lose money.

Take comfort! You won’t suffer that fate, because you are implementing a well-thought-out financial plan customized for your needs and goals by Eaton Financial Group.

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