Investing: In Personal Finance, Past Performance Is Not An Indicator Of The Future: How To Make An Informed Investment Decision

I shouldn’t have quit my job, he lamented for the tenth time. We had been talking for a little over an hour. She described in great detail how successful she was and how accomplished and appreciated she was at work. And then she left him when she got sick. I didn’t ask the one question that was on my mind: but what held you back in the 15 years since then after you got better? I was being nice

But her voice stayed in my head. How many of us live in the past! We cannot let go of it easily. Many of us like to routinely rearrange our lives, rearranging some blocks from the past. If only he had studied this instead of that; or taken this work on that; or lived in this city than that. And so. We make decisions. All the time. It’s unfair to us if we go back and question that, because we can only choose one of the many options that we had then. That’s how it is.

There is a mirage at play. The successful lives of accomplished people are gloriously portrayed in public. Many find it inspiring to hear these stories. Only partially, I think. Where one is today is known. And then we refit a template on all those correct choices that person could have made. As if those were the only options they had. How biased is that!

At every turn, one will be faced with choices. Many of them will not be able to deliver. Some will turn out to be right. And catapult one to fame. We selectively look at the things that went well. We make it look like those were the specific deliberate choices. As if those steps to success were so well known and so well laid out. No. Enough awkwardness happens. Except those stories that didn’t end well don’t get as much attention or analysis.

The problem with these generalizations of success is not just this selective bias. But a dangerous oversimplification of decision making itself. Most like to believe that a path to success can be specified. We discount the reality that at all times a choice was made, and that choice had a high probability of failure. We don’t like the word luck, and we attribute success to deliberate choices, made not by chance but prophetically.

Investing is difficult for this reason. We choose a stock, a bond, a fund, a property or whatever else we like to invest in. If it turns out to be good, we are satisfied with ourselves. We may have cracked the code, we thought. It turns out to be bad, we look at all those choices we didn’t make and we’re filled with guilt. IPOs are routinely overpriced while offered and underperform after listing because we suffer from this bias.

We lose a winning IPO and tell ourselves that the only way to make up for that loss is to buy the next one. The next one will be priced high given this line of eager investors. Poorer and poorer issues will start to hit the market, because investors are adjusting a template for every IPO that comes in. So much so that many will swear that you can’t lose money on an IPO, you have to trade high.

The data does not support this belief, as popular as it is. The good ones are rarer; the bad and the ugly are too many; and investors can not know. The other extreme reaction to this fiasco is another group of investors who will stay away from IPOs altogether. They will have nothing to do with this game, because they believe that there is no money to be made. Caught in the middle are the experts who must rate and rank IPOs and make recommendations. They grope and they are right and most are wrong, and since people forget, all is well.

We just can’t deal with regret. We deny; we justify; we blame Sheena Iyengar wrote years ago that the presence of too many options makes it difficult for the human brain to make decisions. The irony is that people don’t like it if there aren’t many options; the greater the number of options, the less likely it is that people will make decisions easily.

Is there a template for investing in stocks, people ask. There must be something to help you choose the right stocks to invest in. While most of the world believed that stock markets were wild speculation or expensive gambling, Benjamin Graham led the way in 1934. He proposed what we now know as fundamental analysis. Stock prices are driven by underlying merit, he said, lending nobility to a much-maligned profession.

In the years since then, people have played every trick other than the hard work and intensive analysis that Graham proposed. There is no fail-safe template yet; but there is a solid approach to choosing stocks. The hard work of understanding the business, analyzing the numbers, evaluating the managers, and making a judgement. Nowhere is this a prediction. A judgment is only as strong as the information on which it is based.

The best stock pickers understand that they may have missed something; that something could change and that they could not adequately evaluate. Therefore, they remain humble; they remain willing to be proven wrong; they know that new information can change all their assumptions. That’s why they don’t look to the past to connect the dots and make a template; they work dynamically and are tuned to the future.

This approach is difficult. It takes courage to make a decision and dynamically evaluate it and correct course on the fly. What can simple people do?

We can work within our context and means to stay focused on the present. We can imagine a future we want and do our best with those assumptions. We can remain dynamic and humble. My friend who quit her job can see that her regret means nothing; she can start over to do something else that will enable her to accomplish more.

Sometimes we don’t realize that the past doesn’t matter as much as we give it credit for. In personal finance, past performance is not an indicator of the future. And that’s a good thing, right?

(The author is president of the Center for Investment Education and Learning.)

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