I have to admit that lately I’ve found myself rolling my eyes at the slew of content written in the financial media with regards to investing opportunities that are based on research, statistics and past performance.
One common mistake almost every investor has made at some point in our past experiences is a tendency to look to historical returns to anticipate future gains or performance. We assume, inaccurately, that past events will occur again in the future with some degree of replication. The simple fact is that no period, no event and no situation is ever exactly the same. There are variations of mistakes that will follow familiar trends, but no period of history has been repeated exactly as before.
Compounding these problems is the fact that the majority of investors rely on past performance as the basis of their evaluation process for prospective investments. We use P/E ratios based on past earnings, look to the historical growth rate of dividends and cashflows and tout a company’s strong history of performance as an indication for future achievements.
Likewise far too often investors are naive in estimating the infinite potential of an investment opportunity by disregarding the fundamentals of investing, neglecting to rebalance and overweighting their portfolios in only the best performing groups of assets. Their belief is that the market can only move in one direction and they don’t take appropriate stock of the situation, potential risks and deteriorating fundamentals that would protect them from risk.
I’ve been caught on more than one occasion in both camps and learnt from those lessons. One of my core strategies is to focus on the current fundamentals of companies by studying operations, short-term strategies and qualitative features that help me to stay grounded and realistic in my opinions of what a company is doing with respect to the past and where I anticipate them to be in the future. Getting too far ahead of myself in either direction from the present skews my interpretation of today’s events and how those relate to future performance.
Don’t forget to contribute your questions to The Personal Finance Clinic which closes on May 31st, 2009.