Problems with Financial Advisers: Past Performance Doesn’t Predict Future Performance

This article may contain affiliate links; there's a possibility I could earn income when you click through one of these links and sign up for an account, make a purchase, etc. This article is written for entertainment purposes only and should not be construed as financial or any other type of professional advice. This post is part of a series on problems I’ve encountered with financial advisers and my day 7 blog post for the #YourTurnChallenge.

A financial adviser once made a presentation to my husband that illustrated how our money invested with his firm (one of the largest financial institutions in the country) would grow over the course of the next 10 years. This projection indicated the trajectory of this growth and even indicated the investment balance each year into the future. This adviser concluded his sales pitch by saying that everything would be fine and he'd take care of our family.

I didn't like the idea of handing my money over to this guy to manage. He had put together projections using the past performance of certain mutual funds. But past performance doesn't predict future performance.

The adviser didn't show him his track record in managing a portfolio or explain his rationale in choosing these mutual funds. I was pretty sure I could identify great-performing funds and then calculate future returns based on those funds' past performance. Actually delivering returns on investments for the unknown future would be difficult. But picking winners from the past, well, that seemed pretty easy.

And finding winners from the recent past is often not that difficult if the market has been on an upward trend in the past couple of years or more.

Besides the fact that past performance doesn't predict future performance is the idea that past good performance is sometimes negatively correlated with future good performance. That is, if a mutual fund has performed well recently, the fund may be less likely to continue perform well in the short term. Shares of stocks held in the fund may rise in value one year, only to stagnate or fall in the following years. So, investing based on the immediate past may not be a good strategy to deliver the exact same returns in the future.

For various reasons, we decided not to do business with the I've-got-you-covered guy.

 

I've since learned a couple of things: 1) giving projections based on the past is a pretty common method of illustrating growth; and 2) if we had invested in these mutual funds, the value would have declined significantly as the market took a sharp downturn shortly after this upbeat presentation.

If ever presented with similar types of projections, I'll remember to look at the fine print. I'll review projections to determine if 1) they offer an appropriate timeline, such as if I had invested in this fund on X date (sometime in the past), then I'd have this many dollars today (which is reasonable) or 2) the projections indicate that I will make X amount in the future (which is wrong). In addition, I'll look for disclaimers indicating that I may not experience the same results.

In my first article in this series, I mentioned that returns are not guaranteed. That statement holds true, whether I'm dealing with a private money manager or one that represents one of the biggest banks in the country.

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