This Is Probably The Biggest Mistake DIY Investors (& Advisers) Make

Here’s a list of things you wouldn’t do:

– Drive only looking in the rear view mirror,

– Pick the winner of the Grand National based on last year’s,

– Choose the lottery numbers based on last week’s winning numbers,

– Decline a date with a new person just because the last one didn’t amount to much,

– Refuse a drink just because last time you had one it led to a hangover.

“Past Performance is not a guide to the future….” is a sentence required for any financial advert or promotion. Everyone is familiar with it but most investors, and many advisers, still use it as a basis for their investment decision making.

All that past performance tells you is how a fund manager did under certain investment conditions; it is an insight into his thinking at the time but doesn’t tell you what they are thinking presently. It may be that a strategy happened to work or didn’t. It doesn’t mean that it will work again or this time around.

There is a weight of evidence that shows that fund managers do not perform consistently well; top fund managers in one period rarely fail to repeat the outperformance in the next or future time periods.

Relying on past performance of funds leads to frustration, impatience and regular switching:

“Fund Manager A has lost it. Fund Manager B has done much better recently, I’m investing with him”.

“Wait a minute, Mr Journalist has just written about Fund Manager C, he sounds good, I’ll give him a try”. 

Which leads to switching costs that destroy long term returns.

Where past performance is useful is to;

– remind us is that stock markets do provide long term returns greater than any other asset class.

– that they have a self-correcting mechanism when investor exuberance gets too great and,

– that in the depth of a crash they do recover and when they do it is usually soon after the lowest point.

The disciplined and patient investor knows this and avoids the cyclical mistake of the herd of buying high and selling low.

The disciplined and patient investor also knows that she is investing according to a personal plan, has short term money available in cash, and understands the path to investment success is to spread her investments globally and across the main asset classes in a portfolio that is low cost.

The disciplined and patient investor doesn’t pay heed to star fund managers, star ratings or a journalist’s recommendation. That strategy is best left to the uninitiated investor and their adviser.

So next time you find yourself perusing the internet deciding which fund is the best one to invest in. Stop, pour yourself a glass of wine and remind yourself it needn’t result in a hangover (unless that is an acceptable cost for what will follow it).

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