Wednesday, April 7, 2010

The Danger of Short-Term Performance.

Every investor ought to have the phrase “past performance is no guarantee of future results” tattooed backwards on their forehead - backwards so they see every morning when they look in the mirror. But sadly, that doesn't happen. And perhaps because of this fact, it's one of the most ignored pieces of investment advice around.The Danger of Short-Term Performance_chart

I personally believe it's ignored (or forgotten about) so much simply because it's so ubiquitous. It's like your mom telling you to tie your shoes when you were a kid - sure it was advice you should heed, but since failing to do so rarely resulted in any calamity, you felt it was little more than noise.

Well, if 2008-2009 showed us anything, it's that sometimes that ubiquitous noise is worth listening to.

Here's another bit of  ubiquitous noise worth listening to: Beware of One-Year Returns.

This is the advice of Steven Goldberg, one of Kiplinger.com contributing columnists. His point is that some funds can put up seemingly stellar returns over the short-term, but those returns often come at a price.

He spotlights Birmiwal Oasis fund which is up 224% since March, 2009 but that fund has a 999% turnover during that period and a volatility that's 2.5 times the S&P 500.

That's a bumpy ride.

That's also an extreme case, I think. But I also think that it's more important now not to be taken in by such astronomically “good” returns.

When you compare the past 12 months to the 12 months of stock market Armageddon of 2008-2009, most funds should have a really good looking return.

I remember when I first became interested in the stock market. It was around the end of  2004, and the funds I was looking at all had returns in the 40-50% range and I thought, “No wonder people get rich in the stock market. What was I thinking not investing before?”

Of course, I later learned that those great looking returns came from the cratering of stock prices in the dot-com bubble burst.

The moral of this post is that context is everything. You need to take the return as part of the bigger picture, and consider the time frame involved. Any funds 1 year performance can only be indicative of the fund's general performance over the type of market during that year.

For example, if a fund did markedly better than its peers during the 2008-2009 period, then that says something about the fund's management during that kind of market upheaval.

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