Past performance does not guarantee future results

What's your opinion on silver? Since equities don't seem to be doing much why don't we switch to gold and silver?" asked my client of several years. This was coming from a client, who had earned rock solid returns from his investments under our PMS, had an asset allocation plan and had benefited tremendously from regular rebalancing of his portfolio. I didn't have an opinion on silver prices. My only fear was that it was moving up too fast for comfort and as an advisor I am averse to suggesting commodities specially ones that have had a speculative run.

It is mandatory for every investment scheme that publishes returns to declare that past returns are no guarantee for future returns. Then why do investors seem to chase those assets that have already had a superb run. Despite years of historical evidence that the best returns are earned when a particular asset class has been badly trashed and at rock bottom, investors seem to care less. There is an enigma about investing in the bubbling asset that escaped their portfolios.

Even if one were choosing equity mutual funds, many investors tend to base their investment decisions based on ratings published by several research agencies. Most of the ratings are based on past performance. You only need to look at a couple of these published issues to realize how easily ratings keep changing and new funds are brought into the top rated list.

Past returns do help in investment planning but should not be the only guiding factor. .Even when using past data you must look at long term data as only this can help you analyze asset attributes in terms of future returns and volatility. In fact looking at returns over market cycles helps give you an idea of performance rather than complicated data like beta, standard deviation or alpha which are widely published. While investing in equity funds you must also consider

1. Scheme objective or principles on which money is managed

2. Costs involved

3. Flexibility in the hands of fund manager to take advantage of market volatility and value.

4. Fund managers tenure with the scheme

5. What factors led to superior performance in the past and if the same conditions will continue in the future.

As you can see not all factors are objective. In long term assets like equity it is very easy for investors to get anchored to past returns. An investor who has had a fabulous 50 % return on equity in the last year need not assume similar returns in the next. Some day the returns will revert to mean. It is best that investors understand this while making financial plans.

If you are investing in an asset on the back of momentum in that asset, be sure that you can time markets and take a timely exit or you can set yourself back by several years in terms of wealth creation. For the majority of us we must let our Financial Plan decide what assets and when to invest in. Have a good asset allocation plan and rebalance portfolio periodically. This is a sure way of ensuring future performance of your portfolio.