When stocks are bullish and most equity funds are rising, making money seems the only factor to consider. But markets aren’t always like that. And you still need to invest your money. So be open, but skeptical, to others’ views and visions, and remember what Clint Eastwood’s Dirty Harry had to say about opinions. (You’ll have to look it up!)
Our overall approach to picking mutual funds and exchange-traded funds is a conservative one. This approach, however, conflicts with the goals of the investor who says: “I want to make as much money as possible as quickly as possible.”
Of course, we all want that. Unfortunately, though, that’s not realistic. But if this goal is unreasonable, what is reasonable?
We’ve all heard with tiresome monotony that in mutual funds, past performance is no guarantee of future performance. Academics tell us a fund’s past performance has virtually no correlation with its future performance.
It’s easy to jump from this premise to the conclusion that a manager with a strong performance will do less well in the future and one with a poor past will soon enjoy better days. This phenomenon is called reversion to the mean. And no less than index-fund proponent, John Bogle, founder of American indexing giant Vanguard, constantly reminds us of reversion to the mean. When he does so, he warns us not to assume a continuance of strong performance.
Draw no conclusions
But low correlation works both ways. Not only does past performance not imply more of the same, neither does it imply the opposite. In fact, with only past performance to go on, future performance of any fund is random.
Does this mean you should simply toss a dart at a newspaper listing of mutual funds to build your portfolio? Far from it.
Mutual funds have more than past gains and/or losses with which to characterize themselves. And if forecasting future returns is a mug’s game, you should become familiar with other characteristics of funds that will help you assemble a portfolio that suits you.
Some characteristics of mutual funds that do provide implications for future performance include volatility, size of companies in the portfolio, degree of diversification, management style and size of the fund.
These factors won’t help you predict gains or losses over the next 12 months. But they do say a lot about the risk you’ll take when you invest in funds that differ according to these characteristics. In our view, the concept of risk refers to the probability that your money will be available, in cash, when you want it. So your most important question when you invest is: “When do I want my money back, with a suitable return, in cash?”
In other words, you should know your time horizon. You may be saving for retirement, for a house, for your children’s education or any number of other goals. Each one has a time frame. And in general, the longer your time frame, the greater the risk you can take.
Four investors: Which are you?
■ The omen-seeker. Always on the lookout for ominous historical parallels. Some of these investors fear that relaxed monetary policies are producing a bubble similar to the housing bubble that peaked in 2006.
■ The visionary. Blockchain technology is the wave of the future, this investor will assure us, so you can’t go wrong buying stocks with ‘block’ or ‘blockchain’ in their name.
■ The weather vane. A convert to optimism (or pessimism), and a believer in the possibilities (or doubt) expressed in the last investment editorial he has read.
■ The skeptic. Being human, the skeptic is alert to possible omens, open to visions (good or bad) of the future, and willing to listen to the views of others. She recognizes that opinions range more widely than reality, that no one can foresee the future, and that progress comes in spurts.
This naturally leads the skeptic to conclude that balance and diversification in your portfolio, not the precision of your forecasts, is what leads you to investment success.
This is an edited version of an article that was originally published for subscribers in the May 4, 2018, issue of Money Reporter. You can profit from the award-winning advice subscribers receive regularly in Money Reporter.
Money Reporter, MPL Communications Inc.
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