Past performance is no guarantee of future results

There is a universal disclaimer that warns investors not to assume that the recent results of any particular investment will continue into the future. Despite this warning, when contemplating potential investment strategies, investors tend to place excessive weight on recent performance. After all, who wants to invest in a fund that lost 20 percent in the past year? That is why fund managers will typically promote recent performance if the recent results have been positive.

Sometimes a fund will have noteworthy performance simply because it was part of an asset class that performed well. If you owned virtually any technology fund in 1999, you probably enjoyed great returns but the same fund probably fared very poorly in 2001 and 2002. If you were looking for a “hot” investment in 2012 you might have noticed how much gold had gone up over the prior eight years. However, since then, gold has performed very poorly.

For decades, conservative investors have been relying on bonds to add stability to their portfolios. For many years, bond funds had delivered impressive, stable, conservative returns. Those funds benefited from a bond-friendly interest rate environment that had mostly been falling — until this past year, at least. A falling interest-rate environment is ideal for bonds.

The question you must ask yourself as a potential investor is not “what was the 10-year track record of the fund?” but “what are the market conditions that exist today and are they conducive for this particular investment?”

The reality is whatever happened recently seems so obvious in retrospect, yet most people are unable to accurately predict which funds or asset classes will be the top performers in any given year. Therefore, it’s advisable to create a diversified portfolio with numerous non-correlated asset classes, and to resist “chasing” the recent hot asset class.