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Why Investors Can’t Kick the ‘Past Performance’ Habit

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David M. Brenner, ChFC®, CLU®

D. M. Brenner, Inc.
Phone : (858) 345-1001
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On Monday, July 19, financial markets hit instant replay.

As fear spread that the Delta variant of Covid-19 might ravage the economy, U.S. stocks fell more than 2% at their lows. Crude oil sank 7.5%, its biggest daily loss in almost a year.


Airlines, oil and gas, cruise lines, hotels and shopping malls got pounded—just as they had in February and March 2020. Grocery stores, online retailers, pharmaceuticals, technology and personal-hygiene stocks went up or held steady; they fared relatively well during last year’s panic, too.

Past performance suddenly felt like a guarantee of future results—but investors should always remember that it isn’t.

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How similar was this Monday to last year’s pandemic panic? Eight of the 20 worst decliners in the S&P 500 this time had been among those with the deepest losses last time. United Airlines Holdings Inc., down 5.5% this past Monday, had fallen 66.9% between Feb. 19 and March 23, 2020. Oneok Inc., the natural-gas company, fell 5.8% on Monday and 74.5% in the 2020 decline. Norwegian Cruise Line Holdings Ltd. dropped 5.5% on Monday and 81.4% in last year’s Covid crash.

Among the biggest gainers: Regeneron Pharmaceuticals Inc., up 0.3% on Monday, after rising 13.7% in the 2020 crash; Clorox Co., up 0.8% on July 19 and 3.2% in last year’s rout; and Kroger Co., up 4.3% on Monday and 5.2% in the 2020 slump.

Then, starting on Tuesday, as corporate earnings announcements elbowed Covid aside, the markets reversed. Many of Monday’s winners went down, and lots of losers rose. Now, in effect, the market was expecting the post-March 2020 recovery to happen all over again.

It was a wacky few days, and investors might be forgiven if they momentarily forgot that the past never repeats itself exactly.

It’s a tough habit to break: We live in a world in which skill and excellence often persist and price is generally a good signal of quality. Great athletes with a “hot hand” seem to score again and again; your favorite restaurant’s food should be as tasty today as it was last month; a luxury car typically drives better than a cheap compact.

And there’s some truth to it in the markets, too. Stocks whose earnings and prices have recently been rising tend to keep winning, while those that have lately been losers often keep losing.

But the stock market is a complex, dynamic system that doesn’t follow the rules of restaurants or cars. Investing is so competitive that history can rarely repeat for long; if any past pattern reliably recurred, so many people would pounce on it that it would soon stop working. Indeed, when the winners-keep-winning patterns reverse, they can deliver devastating losses.

The human habit of pretending that a rearview mirror is a crystal ball is almost incorrigible. Investors like seemingly coherent explanations of market moves, such as those the news media provides. As soon as the market stops going up, those explanations—no matter how arbitrary—tend to make the new “down” world seem more likely to persist.

Finance professor Meir Statman of Santa Clara University analyzed more than a decade’s worth of monthly surveys of individual investors. The proportion who expected stocks to go up over the coming six months rose, on average, by 1 percentage point with every percentage-point increase in the S&P 500’s returns for the prior month. It’s as if investors believe the medium-term future is shaped by the short-term past.

Trying to get people to stop that behavior can backfire.

In a new study in the Journal of Experimental Psychology: Applied, behavioral scientists Peter Ayton and Leonardo Weiss-Cohen of the University of Leeds and Philip Newall of Central Queensland University tested disclaimers about past investment performance on 1,600 people in the U.S.

Roughly 1,000 had at least some investing experience. In 60 rounds of the experiment, the participants chose between “Fund A” and “Fund B.” Each time, they saw each fund’s fees and its gain or loss over the prior month. Those returns varied randomly—but, on average, Fund A would outperform over time, because its fees were much lower.

Strikingly, when many investors viewed the standard mutual-fund disclaimer that “past performance does not guarantee future results,” they chose the fund with higher fees more often.

“A lot of experienced investors seem to believe that the warning won’t apply to them,” says Mr. Weiss-Cohen. “It’s maybe like they think, ‘I can make it work, because I know better.’”

The phrase “does not guarantee future results” may cause investors to conclude—erroneously—that past performance is nonetheless a highly reliable indicator, says Mr. Newall. (Low fees are a much better indicator of future outcomes than past returns are.)

What does discourage investors from chasing historical returns, the researchers showed, is a warning: “Some people invest based on past performance, but funds with low fees have the highest future results.”

That apparently prompts investors to make a social comparison between themselves and others. Who wants to settle for investing like “some people”? Everybody wants to “get ahead of the Joneses,” says Mr. Newall.

So, as you watch the market on its latest wild goose chase after past performance, remember: Some people invest like that. You don’t have to.

Write to Jason Zweig at intelligentinvestor@wsj.com

David M. Brenner profile photo

David M. Brenner, ChFC®, CLU®

D. M. Brenner, Inc.
Phone : (858) 345-1001
Schedule a Meeting