If Past Performance Doesn't Predict the Future, What Should Investors Look At?
In my article Past Performance Is No Guarantee of Future Results, I discussed why investors should be cautious about selecting investments solely because they have done well in the past. That raises an important question:
If past performance doesn't tell us what will happen next, what should we be paying attention to?
While none of us can predict the future with certainty, there are several factors that may help us make more informed investment decisions.
First, consider the economic environment. Interest rates, inflation, employment trends, corporate earnings, and government policies can all influence investment performance. An investment that thrived during a period of low interest rates may face different challenges when rates rise. Likewise, sectors that struggled during one economic cycle may become market leaders during the next.
Second, understand what you own. Many investors can tell me how a fund performed over the last one, three, or five years, but they cannot explain what the fund actually invests in. Is it focused on large U.S. companies? Small companies? International stocks? Bonds? Real estate? Technology? Drilling down further, what companies of that sector is the fund investing in and why are those specific companies the choice within that sector? The investments inside a fund often tell a much more important story than the performance numbers alone.
Third, pay attention to risk. Higher returns are often accompanied by higher levels of risk. A fund that generated impressive gains may have done so by taking significant risks that are not evident from the return numbers alone. Investors should consider whether the level of risk is appropriate for their situation and ability to tolerate market fluctuations.
Fourth, pay attention to costs, but keep them in perspective. Fees matter because they impact an investor's return. However, choosing an investment solely because it has the lowest fee can be just as shortsighted as choosing one solely because it had the highest past performance. Some higher-cost investments may provide access to specialized expertise, unique investment opportunities, or active management that investors find valuable. The goal is not necessarily to find the cheapest investment. The goal is to determine whether the investment's overall characteristics, potential benefits, and costs are appropriate for your objectives. In the end, what matters most is the net result after fees and whether the investment supports your financial plan.
Most importantly, investors should start with their goals rather than with investments.
The real question is not, "Which investment performed best?"
The better question is, "Which investments best support my goals?"
A retiree seeking dependable income may need a different strategy than a 35-year-old professional saving for retirement. A business owner planning to sell a company may have different priorities than a young family saving for a child's education. The "best" investment for one person may be entirely inappropriate for another.
Prudent investing is often less about finding the hottest investment and more about creating a thoughtful plan. A well-designed financial plan can help guide investment decisions during both good markets and challenging ones. It may also help investors avoid the emotional decisions that can occur when markets become volatile.
There will always be investments that have recently outperformed others. Headlines will continue to highlight the latest market winners. The temptation to chase those returns will never completely disappear, but history has taught us that today's star performer is not always tomorrow's leader.
Instead of focusing exclusively on what an investment has done, consider what role it can play in helping you pursue your long-term goals.
After all, successful investing is about having a strategy that can help support your financial future for years to come.
Past performance tells us where we've been. Thoughtful planning is what guides us to where we want to go.
The Wealth InFormation Lady®
