Any time you read any financial prospectus or ad, or watch a commercial about any investment opportunity, or really, ingest any financial media at all, one phrase will always show up in one form or another:
“Past performance is no guarantee of future results”
This phrase deserves more scrutiny, I believe. After all, it’s practically the only thing the whole investment world agrees upon.
What does it mean?
The “past performance” phrase is, put bluntly, a CYA clause. It’s there so that anyone can sell on the basis of what a product has done in the past and is (presumably) expected to do in the future, but at the same time, allows them to wash their proverbial hands of the consequences.
“This hot stock returned 800% last year! Buy it today!”
“You will make 12% just by investing in loaded mutual funds.”
Even reasonable, non-batty proclamations have to have a CYA clause in them. Remember all the pundits who said that real estate was always a good investment? That may have seemed reasonable in 2006. Not so much in 2009.
Where did it come from?
In short, those who say this do so because they have to. It’s the law.
The Securities Act of 1933, written in response to the Great Depression, has a stipulation named Rule 156 regarding “Investment Company Sales Literature“. You can read it all the way through, but it basically says that one just can’t go around slinging whatever sales claims you want. The word “misleading” is used 10 times in the text.
Did it become more prevalent recently?
1933 was a long time ago, and my personal memory isn’t all that long, but I can’t help but feel like the phrase has become used more recently, in my lifetime. Perhaps it was just what I was paying attention to at the time, but it just started to appear.
I can’t substantiate this feeling, but I can point to an amendment made effective in 2003 which added some more specific clauses to Rule 156. This is around the time that I remember hearing the phrase become more prevalent. (Can anyone corroborate this?)
Does it actually mean anything?
Well, yes and no.
On one level, it’s obvious to the point of banality. Of course no one is guaranteeing anything. There are very few investments that do. I mean, I still have a few savings bonds lying around that I got when I was a teenager (thanks Grandpa!), which guarantee a certain level of return, but that’s a rarity.
On the other hand, it’s a little bit sneaky. Because when you’re looking at an investment product, in most cases, at least to an average investor, past performance is almost the only criteria we have to go on!
For example, let’s say that you wanted to invest in a broad market index mutual fund, such as an S&P 500 index fund. (Recall that this is the advice Warren Buffet would give to his own wife after his passing.)
Anyway, so it’s not considered controversial these days to invest in such a fund. We believe that the 500 companies that comprise the S&P 500 will, over the long term, rise in value.
Why do we believe that?
It’s called “past performance”. These companies have always risen in the long run in the past.
Now , in this particular case, we’re talking about survivorship bias here, in that if a company that’s part of the S&P 500 tanks, it will be replaced by another company that’s doing well.
But what about the broader market? We tend to believe that it will rise in value over the long term too, right?
The only other piece of information we have, other than past performance, is nothing less than whether we believe in the viability of the continued economic growth of the U.S.
If you believe, you’ll buy and hold.
And that’s the problem I see here: you have two options for making a decision:
- Belief (which is unreliable and anti-rational)
- Past performance (which we are supposed to accept isn’t reliable either)
If I had to choose one to bank my investment future on, it’s past performance. It may be no guarantee, of course, but it’s the best thing we’ve got. Too bad.
But enough about me. What do you think about the statement that “‘past performance doesn’t guarantee future results”?
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