Investing backwards is easy. Here is how it works: you take a look at a stock/mutual fund/asset class/allocation that has performed very well over the last few years and that’s where you invest. Done. Super easy. The problem is that investors do not make money looking backward – that money has already been made. Investors only make money from buying things today that will do well GOING FORWARD, not backward.
Let’s take a look at a common trap that investors and advisors fall into: buying a mutual fund with great performance. It makes some sense: “xyz manager has outperformed the S&P 500 by 3 percentage points a year over the past three years. This guy is great at stock picking. I want to invest with him”. This is “investing backwards”.
Let’s take a look at how this turns out for our investors. The Persistence Scorecard shows us that “out of 641 domestic equity funds that were in the top quartile (top 25%) for the two year period as of March 2014, only 7.33% managed to stay in the top quartile at the end of March 2016” – just two years later. But that’s not all. The study also shows us that if your fund is in the top quartile over a five year period that the BEST odds are that the fund ends up in the BOTTOM 25% of all funds over the next five year period – a 29.5% chance! Not only are the odds significantly against this investor’s fund maintaining its great performance, the odds of this fund becoming one of the worst performers are high.
We often see account statements or proposals from other firms when dealing with prospective clients. More often than not, the competing firm is investing backwards. They load up the portfolio with the best performing funds and overweight all of the asset classes that have done great over the past few years. They show you the past performance of that portfolio, which is great, and say “look how much money you would have made”. Often, ACTUAL performance of ACTUAL portfolios run by the firm are non-existent. Unfortunately investing backwards significantly increases the odds of terrible future (actual) performance.
Now imagine instead of losing money every time you invested backwards you received a small electrical shock. As the studies above show, it takes time to actually show you the mistake you made – so maybe you receive a shock every 3 years when you realize you bought a hot fund that went cold. How many shocks/years before you learn what you are doing wrong and stop investing backward? 5? 10? 100? That’s a long time and you cannot afford massive under performance of your investments for a time period that long. The stock market is an expensive place to learn.
As a trader for a decade I traded all day, every day – sometimes making over 100’s of trades in a single day. Every time I bought a big up move, only to see the price start falling as soon as I bought, I lost money. Now losing money is not quite an electrical shock but it’s similar and not fun nevertheless. I have probably been “shocked” about 100,000 times for trading backward (give or take), so I am hypersensitive to its presence. I only made money as a trader from buying low and selling high – so I was “taught” to make trades that were forward-looking. The past did not matter to me.
My point is: invest forward! Avoid what is “hot” now, and look for what will be “hot” in the near future. It’s hard to do, but your retirement account will thank you. Investing backwards is a common mistake all investors can make. You cannot afford “mistakes” with your money. Take a look at your most recent account statement and try to identify if you or your advisors are investing backward. Again, the stock market is an expensive place to learn. Don’t let someone else “learn” with your money.
Charles Brown is a Portfolio Manager and Financial Advisor at M. Brown and Associates in Naperville, Illinois
**The above article is informational in nature only and is not a recommendation to buy or sell securities. All information is gathered from sources believed to be reliable, but neither Charles Brown nor Ausdal Financial Partners, Inc guarantees the accuracy of the information. All investments carry a degree of risk. Individuals should consult with their tax and investment professionals before making changes to their investment portfolios.
***Securities and Investment Advisory services offered through Ausdal Financial Partners, Inc, 5187 Utica Ridge Road, Davenport, IA 52807 (563)326-2064. Member: FINRA/SIPC. M.Brown and Associates and Ausdal Financial Partners are independently owned and operated