Be Careful When Looking at Historical Returns

large male black bearBy Nick Clay

One thing you’ve probably heard from your financial advisor is “Past performance is not indicative of future performance,” yet so many people use past performance as their only yardstick when comparing different types of investments. What’s worse is when people are looking at short term returns with the “what have you done for me lately?” mentality.

Don’t get me wrong, historical returns play a part in analyzing investments. One may want to know how an investment has performed over the last three to five years, but what’s the problem with looking at the last three to five years? It leaves out 2008 – a year when the S&P 500 was down nearly 40%. It’s just as important to know how an investment has performed in a down market.

If you are looking at historical returns, one of the most important things to know is how the investment performed in a down market.  Or a bear market? Since the end of 2008 the S&P 500 has doubled, and just about any type of equity investment will look decent on paper since 2008. But how did a potential investment perform in a year like 2008? If the particular investment hasn’t been around that long, then you can only use an educated guess on how it will perform in a bear market.

Let’s take a mutual fund that many are familiar with, The Growth Fund of America (AGTHX). If you only analyze the last five years you will see a fund up a whopping 111% (22.2% avg/year). What happens if you throw 2008 into the analysis? The fund is up a modest 28% (4.67% avg/year) over roughly six years – big difference. Maybe the better analysis is the fund compared to other similar funds over six to ten years.

One thing we stress when advising clients is to focus on the long term, not the short term. As we’ve discussed in previous blog entries, over the long term, the equity markets are a very good place to invest.  Historical averages of a moderate 70% equity/30% bond portfolio return 9.39% a year over the previous 78 possible periods.*

There are many ways to analyze investments and using historical returns is what most novice investors focus on, because it’s the only thing they know how to do. Don’t make that mistake. No matter what phase of life you are in, your best bet is to work with a trusted advisor to develop a long term plan.

*2013 Ibbotson® SBBI® Classic Yearbook

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