Past Performance Means Little!!

Recently I was discussing the advantages of leaving the brokerage business and starting a registered investment advisor business with a colleague. He said the main advantage was he did not have to use institutional money. He proclaimed he had developed a stock picking model.

This model had earned over the last 10 years an average return of 19%. WOW that is very impressive. Until I asked if this was live or did he have clients that realized these returns.

His answer, was no. This was the return software generated when he used different criteria. In other words, he optimized the portfolio based on past data.

It is very easy to build a portfolio of the best stocks and earn outstanding returns based on past performance. Unfortunately, for him and his clients’ past performance is no indication of future results.  Yesterday’s hot stocks could be tomorrows dogs.

He does not realize that he is gambling and speculating with his clients’ money. He can justify each trade with some signal or trend change or some other indicator.

Unfortunately for this trader his hypothetical success will be met with long term failure. Successful investing is NOT gambling and speculating. Successful investing involves following a prudent process and remaining disciplined to that process.

OK I am going to say this with the risk of repeating myself. There are three simple rules to successful investing:

  • Own equities and fixed income.
  • Globally diversify.
  • Rebalance

Each of these rules sound very simple and should be very easy to follow. Until one of your friends or someone you know tells you something that scares into panicking and selling. Or even convinces you that the next hot stock or asset class will make you rich.

Successful investing is just that investing which means long term. One of the reasons the equity markets provide an excellent return long term is the volatility both up and down. We need to live with the downturns in order to experience the upturns.

Stock picking and market timing may be more fun to talk about because it is exciting, especially when you win. But like a gambler, market timers and stock pickers get a high off their trading.

It’s ok to gamble and speculate with fun money but not money designated for a long term goal, like retirement. If you really want to gamble and speculate go to Las Vegas, at least you will have more fun when you lose.

To successfully investor you need to fire your broker/agent and hire an investor coach/fiduciary adviser.

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