The perils of investing based on past performance

Carl Richards is a Certified Financial Planner™ and creator of the Sketch Guy column, appearing weekly in The New York Times since 2010.  The following article is reproduced with permission from his weekly newsletter and his website can be found here.

Greetings, Carl here.

Investing based on past performance is like driving while looking in the rear view mirror.

It. Will. Cause. Accidents.

Now, I know we’ve all heard the disclaimer repeated on every single investment advertisement: “Past performance is no indication of future results.”

We hear it often enough.

We might even believe it.

But then… what’s the first thing we do when we have a pool of money to invest?

In fact, what feels like the first right thing to do?

No prizes for guessing right because you know the answer… The first thing we do when we have money to invest is look for the investment that has recently done well. We look at the track record.

I get it. It feels like that makes sense. If you’re going to hire a contractor to remodel your kitchen, it would be reasonable to go look at the work they’ve done in the past and expect that quality of work to continue, if not improve.

But when it comes to investing, this does not hold up. Because investments go in cycles, looking at how things have done in the recent past leads us to buy high, which inevitably leads us to be disappointed, and then we sell low, only to repeat the process over and over and over.

Investing in the rear view mirror doesn’t make sense.

Turns out, investing based on what you think is going to happen in the future doesn’t make sense either.

The only thing that makes sense is to invest based on our own goals and values.

So forget looking in the rear view mirror. Forget predicting the future. And spend the time to get clear about where you want to go and what the money is for.


P.S. As always, if you want to use this week’s sketch, you can buy it here.