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Shortly after the 2018 Winter Olympicsclosing ceremony, I started thinking about the 2022 Winter Olympics. Will Russia dominate figure skating? WillNorway and Germany win the most medals?
My questions reflect a deep-rooted acceptancethat past performance is key to forecasting future events.
Why don’t all top-performing investmentscontinue to outperform? It’s complicated.
Projecting a country’s future medal count inthe Olympics is based on a finite number of related factors, includingathletes’ collective skill level and previous performance. But the factors thataffect investment outcomes, such as market volatility, political and economicclimate, and expectations around company or sector performance are cyclical andrandom.
When you’re selecting mutual funds, you haveeasy access to rankings, ratings, and historical returns. However, researchshows that top-performing funds rarely make it to the medal podium twice.
Break the cycle of making poor investmentdecisions
We’re creatures of habit. It’s human natureto rely on what we’ve learned in the past—we won’t (knowingly) touch a hotstove twice, in other words.
Old habits die hard though. While you mightnot be able to eliminate the influence of past performance when selecting yourinvestments, you can take measured steps toachieve a more balanced approach.
1. Be aware of the situation. We makedecisions based on our experiences every day. For example, if you’ve hadseveral positive experiences eating at the food truck outside your officebuilding, you probably won’t be disappointed if you eat there again today. Thefactors that affect your experience—menu, food quality, and value—areconsistent. But investing is different.
Market performance and other factors areunpredictable at best (and erratic at worst), so it’s unproductive to rely on a“past performance predicts future results” mentality. In fact, research showsthat historical investment performance appears retrospectively more random thanpredictive.
2. Control what you can. Focus your energy oncosts and asset allocation. There are predictable benefits to choosing low-costinvestments and maintaining an appropriate asset allocation. Low-cost investments can help you keep moreof your returns, and a suitable asset allocation can help you manage risk.Actually, for investors with a well-diversified portfolio, your assetallocation affects your returns more than any other choice you make.†
On the flip side, there are no predictablebenefits to making investment decisions based on past performance.
3. Be disciplined. If you have a simplefinancial plan with clear goals and an appropriate asset allocation, haveconfidence in your portfolio during good times and bad. And once you create afinancial plan, it’s easy to be a disciplined investor—all you have to do isstick to your plan.
Coaches can be the key to unlocking anathlete’s potential. A good coach teaches self-awareness, control, anddiscipline—qualities that can lead to consistently better performance. If youneed help making the best possible investment decisions, consider partneringwith your own “coach”—a financial advisor who can help you get on track andmaintain momentum until you reach the finish line.
Click here for the original blog from Vanguard.