Investing on past returns
All products come with a warning that past returns are not an indication of future returns. However, it is even more dangerous than that –
– a sustainable return given the level of risk that investors are willing to take in that asset. From time to time, due to specific circumstances, investments can provide above average returns, even for a prolonged duration. Take as an example, the returns achieved by property over the past decade – investors received in excess of 20% per year, even better than equity investors did. There were very specific reasons, such as the systematic decline in interest rates (there were many other factors as well). The long-term average return for property is closer to 10% per year.
If you now look at the past returns of property, you would be tempted to jump in. However, it is likely that the future returns might be below average – the conditions that fuelled the returns are no longer present. The same applied to IT shares at the end of the Nineties l eading up to the 2000s, or construction shares in the run-up to the 2010 FIFA World Cup.
Product providers are guilty of using superior past returns to promote their products, right at the peak of the investment cycle. It makes for enticing billboards! Do not fall for this. By the time a return is worthy of billboards, be wary.
Study the three-, five- and 10-year returns and then the individual annual returns at different times to get a better understanding of the potential returns and risk. If asked, most asset managers and financial advisers will provide their estimations of a long-term average expected return, which is a better hurdle expectation.