How often have you read a financial article or looked at a financial graph and noticed the warning “Past Performance Does Not Guarantee Future Results”? Almost every one of these articles or graphs includes this warning to avoid guaranteeing performance. Yet, Morningstar, the company that provides analysis of mutual funds and ETFs, rates these investments primarily on their recent performance against “comparable” funds. Morningstar uses a scale of 1 to 5 stars with 5 being the highest.
One of the biggest mistakes many individual investors make is to chase performance. Let year’s hot performing stock or fund is often a poor performer in the following year. Individual investors jump into these hot performers only to see them lag the stock or fund they sold. Chasing performance results in substantial underperformance by individual investors as documented by the Dalbar Study. Unfortunately, the most respected fund analysis company, Morningstar, uses a rating system that encourages performance chasing.
A recent Wall Street Journal article, The Morningstar Mirage, assessed the value of the Morningstar rating system as it pertains to future performance. The conclusion was that many funds that achieve a 5 star rating subsequently underperform. Many times, this is related to flows into the funds. A small fund that has had good performance can lose its focus when it is inundated with new money related to its 5 star rating. To be fair, Morningstar acknowledges that their star rating system is based on past performance and does not guarantee continued outperformance. Unfortunately, since Morningstar serves as the basis for fund selection by many investment companies and advisors, proposed portfolios will contain a collection of 4 and 5 star funds without much thought given to the long-term or future performance of the funds.
With all this in mind, here are some things an investor can do:
- Know what you own. Many people spend more time researching which washing machine to buy than the latest purchase in their portfolio.
- Avoid the urge to make frequent changes to your portfolio based on short-term trends.
- Invest in a portfolio that is right for you. This should be based on your time horizon, risk tolerance, and financial objectives.
- Diversify your investments. Owning a portfolio more representative of the overall market is less susceptible to the ups and downs of a single company.
- Apply risk management techniques to your portfolio.
If you are uncertain about your investments, a financial advisor can help you with the many factors and decisions involved with investing. Feel free to contact us with any questions at info@L2Wealth.com.
Disclosures
All written content on this site is for information purposes only and should not be considered investment advice. Opinions expressed herein are solely those of L Squared Wealth Management LLC unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made by our firm as to another party’s informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant, or legal counsel prior to implementation.
Advisory services are offered through L Squared Wealth Management LLC, a California registered investment advisor firm. The presence of this website on the Internet shall not be directly or indirectly interpreted as a solicitation of investment advisory services to persons of another jurisdiction unless otherwise permitted by statute. Follow-up or individualized responses to consumers in a particular state by our firm in the rendering of personalized investment advice for compensation shall not be made without our first complying with jurisdiction requirements or pursuant an applicable state exemption. Advice may only be provided after entering into an advisory agreement with L Squared Wealth Management LLC.
Past performance is no guarantee of future results.
