Past weather is no guide to future weather

We are going on our family holiday in a couple of weeks. Before going away, my wife always put the destination in the weather app on her phone and checks out the weather for weeks ahead of us going. She excitedly tells me how sunny it is where we are going but it doesn’t always turn out that way. Last year we went to France and the weather was great all the way up until we went away. We had sunshine for 2 weeks and constant rain for the third week (Side note: 3 week holidays are great, you should try to take them as much as you can).

We all understand that the weather forecast today doesn’t mean it’s going to be sunny in a few weeks time. Yet when it comes to investing we can’t stop looking at past performance and thinking that future returns will be the same. The Central Bank think it’s a serious enough an issue to make investment firms add “Past performance is no guide to future performance” in all investment advertisements. We all ignore this warning though.

The fact is, we have no idea which fund or investment will be number 1 over the next 1, 2 or 3 years. If you believe in active management, your star fund manager may leave, have a bad year or the strategies he uses may no longer work anymore. If you are a passive investor, which region or sector will do best? We don’t know.

What we can use past performance for is as an indicator. We can see that regions with stable economies and governments will consistently perform over the long term and tend to be less volatile. We can also use past performance to indicate the levels of crashes that have happened as part of your risk assessment process.

While it is a lovely 27 degrees on the Costa Brava right now, I know that it may not be in a couple of weeks time!

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