Description: “Past performance is not an indicator of future results.” It’s become a cliché, but there’s a reason for stating it beyond compliance concerns.
Closer Look at Past Returns
By Tim Courtney, Chief Investment Officer
You’ve probably seen the disclaimer before: “Past performance is not an indicator of future results.” It’s become a cliché, but there’s a reason for stating it beyond compliance concerns.
To understand why, it’s important to look at how returns can drastically change depending on the starting point from which they are measured. For example, if you look at the S&P 500 since September 2000, it looks horrible – returning approximately 5.4 percent per year on average1. However, if you rewind just a little further back to December 1994, it looks fantastic – with 10 percent return per year on average1. The time you choose to look from can have a huge impact on the performance of an investment and what you may be expecting moving forward.
The ending point of the timeframe considered can also skew returns. The investment management industry’s standard is to look at returns over one-, three-, five- and 10-year periods. The purpose of this is to be able to get perspective on recent as well as longer-term performance. But what happens in the most recent months is also included within the other time frames, so large recent moves will influence each of the other time frames and give the appearance of consistently higher or lower returns.
Trailing returns (five and 10 years for example) will have historical returns eventually fall off the record. The most recent 10-year period leads stocks right to the doorstep of the Great Recession of 2008 and 20092. Over the next few months, these poorly performing months of the recession will slowly begin to drop off, gradually making 10-year returns look much better than they have recently.
Sometimes when you notice large differences in returns by changing the starting and ending points, it can be indicative of an unusual valuation event within that period. 2000, for instance, was the height of the tech bubble and the dotcom bust3 – which is why the S&P 500 has lower returns when using this particular starting point, due to the sky-high valuations of many companies then.
Remember when the news was filled with examples of Japanese companies buying iconic American assets in the late 1980s4? Japan’s market return dwarfed U.S. stock returns then5 and this made international returns going back five, 10, 15 years and longer look consistently larger. But Japan’s market had become historically expensive during this time5, and Japan’s returns from 1989 on were paltry because of the valuations.
We need a way of measuring results and comparing apples to apples. For this, the common return metrics can offer help. Soon you will notice 10-year stock returns moving much higher as the poor recessionary return months are discarded. We should take a paraphrased version of the disclaimer into account: that past performance may not be the best indicator of future results.
1 Yahoo Finance – S&P 500
2 Investopedia - The Great Recession
3 Investopedia – Dotcom Bubble
4 Business Insider ¬– The true story of the 1980s, when everyone was convinced Japan would buy America
5 Yahoo! Finance – Nikkei 225
PAST PERFORMANCE IS NOT AN INDICATION OF FUTURE RETURNS. Information and opinions provided herein reflect the views of the author as of the publication date of this article. Such views and opinions are subject to change at any point and without notice. Some of the information provided herein was obtained from third-party sources believed to be reliable but such information is not guaranteed to be accurate. In addition, the links provided within are for convenience only and the provision of the links does not imply any sponsorship, endorsement, or approval of any of the content. We do not guarantee the content or its accuracy and completeness. The content is being provided for informational purposes only, and nothing within is, or is intended to constitute, investment, tax, or legal advice or a recommendation to buy or sell any types of securities or investments. The author has not taken into account the investment objectives, financial situation, or particular needs of any individual investor. Any forward-looking statements or forecasts are based on assumptions only, and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. Any assumptions and projections displayed are estimates, hypothetical in nature, and meant to serve solely as a guideline. No investment decision should be made based solely on any information provided herein and the author is not responsible for the consequences of any decisions or actions taken as a result of information provided in this book. There is a risk of loss from an investment in securities, including the risk of total loss of principal, which an investor will need to be prepared to bear. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular investor’s financial situation or risk tolerance. Exencial Wealth Advisors, LLC (“EWA”) is an investment adviser registered with the Securities & Exchange Commission (SEC). However, such registration does not imply a certain level of skill or training and no inference to the contrary should be made. EWA may only transact business in those states in which it is registered, notice filed, or qualifies for an exemption or exclusion from registration or notice filing requirements. Complete information about our services and fees is contained in our Form ADV Part 2A (Disclosure Brochure), a copy of which can be obtained at www.adviserinfo.sec.gov or by calling us at 888-478-1971