Ten investing truths

Avoid chasing returns

Don't rely on past performance as a guide to the future

Chasing returns is one of the most common mistakes that investors make. It's like driving using the rear-view mirror. You can see clearly what is behind you - but not what lies ahead.

For example, you see a return of 40% and curse that you weren't invested a year ago. So you decide to put your money in that investment in the hope that it will do the same thing in the year ahead.

But only rarely will last year's best performer repeat their stellar performance - whether you look at asset classes, investment managers or individual stocks.

Asset class performance 1984 - 2004

Table of annual asset class performance

Asset classes

Here's a simple example that explains why chasing returns is dangerous.

The chart shows the main asset classes and their percentage return each year between 1984 and 2004.

You can see from the chart how rare it is for the same asset class to have the best performance two years in succession. It has happened only twice in the past 20 years. History has shown that if you invest in the asset that performed the best last year, it is unlikely to have the best performance again this year.

Investment manager

Today's best performing investment manager is often relegated to the middle of the pack or worse in years to come, so you need to do your research to find a manager that consistently produces good returns.

Individual stocks

A booming stock doesn't ensure future returns. Just think of the investors who invested at the height of the technology boom, only to lose money when the market fell.

 

So... what criteria do you use to select investments?

There are a few practical steps you can take.

  1. Learn to identify stocks that are undervalued in the current market. Finding hidden talent will give you a starting point for finding undiscovered gems.
  2. Do your research. A manager's investment process, and the resources and experience they can deploy are at least as important as past performance of stocks. Check out some of your research options.
  3. Diversify your portfolio. It's a basic investment 'rule of thumb' so understand what diversification means for your investment strategy.
  4. Stick to your guns. Don't panic and change your investment strategy every year. Instead, spend time developing an investment strategy that suits your circumstances and goals, and give the strategy time to work.
  5. Finally, and most importantly, seek advice from a financial adviser who can help you develop a disciplined approach to investing.

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