Why past performance does not predict future?

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get_g0ing
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Why past performance does not predict future?

Post by get_g0ing » Fri Mar 22, 2019 11:02 pm

When it comes to stocks or stock market, why is it said that past performance does not predict future performance?

Whereas in most areas of life, that does appear to be the case:

- In sports, the performance is not random. Good players tend to perform good.
- In education, a 4.0 GPA in one semester, doesn't get 2.0 in the next.
- In job hiring, companies actually say "past performance is a good indicator of future performance". So they look at internships, past work, etc.
- Companies that produce reliable cars like Toyota, Honda, keep producing reliable cars. It doesn't vary much year to year.

Thanks for answering.

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Dialectical Investor
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Re: Why past performance does not predict future?

Post by Dialectical Investor » Fri Mar 22, 2019 11:05 pm

People quote others to argue their positions without regard to the context or validity of the original quote all the time. That's what's going on here, too.

magicrat
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Re: Why past performance does not predict future?

Post by magicrat » Fri Mar 22, 2019 11:17 pm

Your four examples are all things that are pretty steady, and you're saying they will continue to be steady. But the stock market is highly volatile. Please provide some examples of highly volatile systems where the patterns persist.

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Re: Why past performance does not predict future?

Post by Fallible » Fri Mar 22, 2019 11:26 pm

get_g0ing wrote:
Fri Mar 22, 2019 11:02 pm
When it comes to stocks or stock market, why is it said that past performance does not predict future performance?

Whereas in most areas of life, that does appear to be the case:

- In sports, the performance is not random. Good players tend to perform good.
- In education, a 4.0 GPA in one semester, doesn't get 2.0 in the next.
- In job hiring, companies actually say "past performance is a good indicator of future performance". So they look at internships, past work, etc.
- Companies that produce reliable cars like Toyota, Honda, keep producing reliable cars. It doesn't vary much year to year.

Thanks for answering.
Nobody can predict the future with certainty, including your examples.
"John Bogle has changed a basic industry in the optimal direction. Of very few can this be said." ~Paul A. Samuelson

MathWizard
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Re: Why past performance does not predict future?

Post by MathWizard » Fri Mar 22, 2019 11:37 pm

Three part answer:

1) Whether you talk about individual stocks or the market is important.
Individual stocks are extremely volatile compared to the market. They can go to zero. Unless a country's economy totally collapses, the market does not go to zero.

2) Time is important. Rolling 30 year returns in the market are positive,and beat inflation. This is a qualitative statement, not quantitative.

3) They aren't a constant return like a CD but average better returns over time , the statement just refers to the volatility in the market which people who are used to savings accounts and CDs need to be aware of.

tibbitts
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Re: Why past performance does not predict future?

Post by tibbitts » Fri Mar 22, 2019 11:38 pm

get_g0ing wrote:
Fri Mar 22, 2019 11:02 pm
When it comes to stocks or stock market, why is it said that past performance does not predict future performance?

Whereas in most areas of life, that does appear to be the case:

- In sports, the performance is not random. Good players tend to perform good.
- In education, a 4.0 GPA in one semester, doesn't get 2.0 in the next.
- In job hiring, companies actually say "past performance is a good indicator of future performance". So they look at internships, past work, etc.
- Companies that produce reliable cars like Toyota, Honda, keep producing reliable cars. It doesn't vary much year to year.

Thanks for answering.
The general theme here is that the past does predict the future in terms of overall market returns - we discuss that with regard to SWR all the time, for example.

But academic evidence suggests that individual stock picking performance hasn't persisted in the past. I know, ironic: we base our statements about past performance not persisting entirely on... actual past performance.

typical.investor
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Re: Why past performance does not predict future?

Post by typical.investor » Fri Mar 22, 2019 11:42 pm

get_g0ing wrote:
Fri Mar 22, 2019 11:02 pm
When it comes to stocks or stock market, why is it said that past performance does not predict future performance?

Whereas in most areas of life, that does appear to be the case:

- In sports, the performance is not random. Good players tend to perform good.

I disagree. Have a look at how efficient free agent signings are.
(Hockey comment) For the most part, with the unrestricted types, you’re paying a large free-agent premium for players past their prime, and almost always you’re paying players for what they’ve done, not what they can do.
Obviously good performance has momentum and people are paying with hope it will continue, but then there is the inevitable reversal.

For the NFL, it's being argued that the way to success is get a good quarterback on a rookie contract. After that they eat so much salary cap space that your team suffers in other areas.

And why didn't the Steelers sign Le’Veon Bell? When he sat out over contract guarantees, they found other much cheaper running backs could replicate his performance.

If a stock has a good run due to both particular economic conditions and expanding multiples surrounding continued expectations of its performance, the price per dollar of earnings will be very high. Sure things can continue to climb for a long time, or things could reverse if something in the company or market changes and its expense isn't justified anymore as something that hasn't been so stellar in the past can product similar returns for less cost.

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get_g0ing
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Re: Why past performance does not predict future?

Post by get_g0ing » Sat Mar 23, 2019 1:00 am

magicrat wrote:
Fri Mar 22, 2019 11:17 pm
Please provide some examples of highly volatile systems where the patterns persist.
Hi,
I don't know what you mean by volatile systems. Can you share examples of such systems or cases where patterns don't persist (other than the stock market which is already known).

Thanks.

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get_g0ing
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Re: Why past performance does not predict future?

Post by get_g0ing » Sat Mar 23, 2019 1:05 am

Fallible wrote:
Fri Mar 22, 2019 11:26 pm
get_g0ing wrote:
Fri Mar 22, 2019 11:02 pm
When it comes to stocks or stock market, why is it said that past performance does not predict future performance?

Whereas in most areas of life, that does appear to be the case:

- In sports, the performance is not random. Good players tend to perform good.
- In education, a 4.0 GPA in one semester, doesn't get 2.0 in the next.
- In job hiring, companies actually say "past performance is a good indicator of future performance". So they look at internships, past work, etc.
- Companies that produce reliable cars like Toyota, Honda, keep producing reliable cars. It doesn't vary much year to year.

Thanks for answering.
Nobody can predict the future with certainty, including your examples.
That's true, but even without absolute certainty it's extremely useful ... the evidence is in how people actually behave in the real world. If someone is looking for a reliable car, for instance, they will pick Honda or Toyota (or another with high past reliability). They will not think: since certainty is not possible, I'll just pick randomly.

DonIce
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Re: Why past performance does not predict future?

Post by DonIce » Sat Mar 23, 2019 1:14 am

get_g0ing wrote:
Fri Mar 22, 2019 11:02 pm
When it comes to stocks or stock market, why is it said that past performance does not predict future performance?

Whereas in most areas of life, that does appear to be the case:

- In sports, the performance is not random. Good players tend to perform good.
- In education, a 4.0 GPA in one semester, doesn't get 2.0 in the next.
- In job hiring, companies actually say "past performance is a good indicator of future performance". So they look at internships, past work, etc.
- Companies that produce reliable cars like Toyota, Honda, keep producing reliable cars. It doesn't vary much year to year.

Thanks for answering.
People do expect the markets to behave in a certain way. For instance, they expect that over decade and longer timescales, equities will go up. Otherwise they wouldn't invest in equities. This is based not only on past history but also on a more general belief in the continuing progress of human civilization. Saying that past performance doesn't predict future performance means that you can't predict the future, not that you can't have some reasonable expectations about it. The 4.0 student may have family problems next semester and get a 2.0, but may return to being a 4.0 student later. Honda may release an unreliable car, but may fix it later in a recall. Markets may crash for 5 years, and go back up later.

But if you see a particular stock or fund that has outperformed in the past, that's where the statement of past performance not being a reliable indicator of future performance is important to pay attention to... it is likely that its past out-performance was a result of circumstances that will not necessarily be repeated in the future.

Dandy
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Re: Why past performance does not predict future?

Post by Dandy » Sat Mar 23, 2019 6:38 am

Some mutual fund managers place outsized bets on certain stocks or industry segments - an investor might look at prior performance and assume that those results will be typical of the future -- which is unlikely.

In sports what percentage of number one prospects or number 1 draft choices go on to be stars? Some for sure, but a lot of them don't.

We have had a 30 year bull market in bonds -- interest rates have fallen from high double digits to low single digits. If you look at a 30 year performance of a bond fund and assume that will be what you will get going forward -- you might be getting a surprise.

In the U.S. stock market there used to be blue chip stocks that seemed to be forever holds e.g. GE, Sears, GM, Kodak, Xerox, etc. Now a blue chip can become a cow chip before you can blink. Change is rapid and can be lethal to established companies. The U.S. stock market has been a world leader -- how will it fare in the future? will it be China? Will everyone have a self driving electric car ? How will that affect the auto industry, the oil industry, car repair shops, gas station owners, taxi drivers, uber/lyft ?

I guess the point is that historical information is somewhat useful but can't be overly relied on. So, don't assume your decision on what fund or allocation you choose based on prior results will give you those results going forward. To me that means there is no set it and forget it investment allocation or withdrawal strategy. You have to avoid tinkering with it but can't forget it either. Are you ready for negative interest rates? hyper inflation? climate change disasters? tax law changes?
If they occur how will that affect future performance vs past performance?

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Vulcan
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Re: Why past performance does not predict future?

Post by Vulcan » Sat Mar 23, 2019 6:47 am

get_g0ing wrote:
Sat Mar 23, 2019 1:00 am
magicrat wrote:
Fri Mar 22, 2019 11:17 pm
Please provide some examples of highly volatile systems where the patterns persist.
Hi,
I don't know what you mean by volatile systems. Can you share examples of such systems or cases where patterns don't persist (other than the stock market which is already known).

Thanks.
Random coin flips
If you torture the data long enough, it will confess to anything. ~Ronald Coase

newinvestor54
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Re: Why past performance does not predict future?

Post by newinvestor54 » Sat Mar 23, 2019 6:53 am

It's because the stock market is dynamic and based on expectations -- so getting outsized future returns means that you have to find stocks that continue to beat expectations. The appropriate analogies would not be that a good baseball player or student continues to be good, but that they keep performing better than anyone expects. Once the expectations change ,the good performance is "priced in" and it's harder to keep exceeding that in the future and easier to fall short.

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Re: Why past performance does not predict future?

Post by acegolfer » Sat Mar 23, 2019 7:25 am

I'll use middle school stats to explain this. In all your cases, the outcome is still random. Nevertheless, we can predict with some accuracy because its stdev is much smaller than the expected value.

OTOH, for stock returns, the stdev is 2-10 times higher than the expected value. This makes prediction practically impossible.

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Re: Why past performance does not predict future?

Post by lostdog » Sat Mar 23, 2019 7:38 am

Dialectical Investor wrote:
Fri Mar 22, 2019 11:05 pm
People quote others to argue their positions without regard to the context or validity of the original quote all the time. That's what's going on here, too.
Thus also happens in the international threads.
I don't invest looking in the rear view mirror and I know absolutely nothing about the future.

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Re: Why past performance does not predict future?

Post by YttriumNitrate » Sat Mar 23, 2019 8:12 am

get_g0ing wrote:
Fri Mar 22, 2019 11:02 pm
When it comes to stocks or stock market, why is it said that past performance does not predict future performance?

That's not the standard saying. The saying is that "past performance does not guarantee future results."

miamivice
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Re: Why past performance does not predict future?

Post by miamivice » Sat Mar 23, 2019 8:16 am

get_g0ing wrote:
Fri Mar 22, 2019 11:02 pm
When it comes to stocks or stock market, why is it said that past performance does not predict future performance?

Whereas in most areas of life, that does appear to be the case:

- In sports, the performance is not random. Good players tend to perform good.
- In education, a 4.0 GPA in one semester, doesn't get 2.0 in the next.
- In job hiring, companies actually say "past performance is a good indicator of future performance". So they look at internships, past work, etc.
- Companies that produce reliable cars like Toyota, Honda, keep producing reliable cars. It doesn't vary much year to year.

Thanks for answering.
- Good players perform good until they get injured and sidelined.
- A 4.0 student sometimes turns into a 2.0 student when classes get hard, due to drug use, or experiences medical issues.
- Employees that are high performing at one company do not necessarily find success at another
- Companies that produce reliable gas cars like Toyota, Honda keep producing reliable gas cars, while demand is slowly shifting to electric cars. Will they produce great electric cars? Who knows.

Past performance often but not always predicts future results.

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Re: Why past performance does not predict future?

Post by oldcomputerguy » Sat Mar 23, 2019 8:28 am

get_g0ing wrote:
Fri Mar 22, 2019 11:02 pm
When it comes to stocks or stock market, why is it said that past performance does not predict future performance?
The actual statement is "past performance does not guarantee future results." The SEC passed rules in 2003 requiring this language be included in fund advertisements and documents.

Yes, by looking at how asset classes broadly have behaved over long periods of time, we get some idea of how they hopefully will behave in the future. But this is not guaranteed.

This article on The Balance might help shed some light.
It’s taken me a lot of years, but I’ve come around to this: If you’re dumb, surround yourself with smart people. And if you’re smart, surround yourself with smart people who disagree with you.

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Re: Why past performance does not predict future?

Post by warner25 » Sat Mar 23, 2019 8:47 am

newinvestor54 wrote:
Sat Mar 23, 2019 6:53 am
It's because the stock market is dynamic and based on expectations -- so getting outsized future returns means that you have to find stocks that continue to beat expectations. The appropriate analogies would not be that a good baseball player or student continues to be good, but that they keep performing better than anyone expects. Once the expectations change ,the good performance is "priced in" and it's harder to keep exceeding that in the future and easier to fall short.
Great answer; I was thinking along the same lines. To expand on this a bit:

I think the answer is the Efficient Market Hypothesis. Essentially, the analogies are wrong because they look only at the value of things and ignore their prices.

Sports teams, limited by funds or a league-imposed salary cap, don't just care how good a player is; they care how good the player is relative to how much he'll cost to sign. When everybody knows the player is good based on his past performance, salary expectations go up. Any company hiring employees needs to do the same. Lots of people argue that a Toyota is more reliable than a Kia based on past performance, but a consumer needs to ask whether a Toyota is worth the premium over a Kia.

These markets exhibit varying degrees of efficiency. Financial markets seem to be very efficient, hence EMH. So as an investor, it's not helpful to know that a company is good when the market has already priced the company's stock accordingly. EMH says (very simply summarizing here) that trying to exploit inefficiencies by very carefully picking stocks of good companies that appear to be mispriced is about as successful as picking stocks at random. So the performance of a stock or mutual fund relative to a similar stocks or mutual funds in the same category over any period of time is random, and subsequent periods of time are unpredictable.

Where past performance seems to be useful is seeing how various types or classes of assets perform relative to each other. For example, we see that stocks are more volatile than bonds which seems to explain a persistent equity risk premium. Or we see that when when stocks go down, bonds often go up. For lack of a better method, I think long-term past performance of broad, global markets also helps us get in the ballpark of how much we need to save and invest to reach our goals.

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Re: Why past performance does not predict future?

Post by magicrat » Sat Mar 23, 2019 9:20 am

get_g0ing wrote:
Sat Mar 23, 2019 1:00 am
magicrat wrote:
Fri Mar 22, 2019 11:17 pm
Please provide some examples of highly volatile systems where the patterns persist.
Hi,
I don't know what you mean by volatile systems. Can you share examples of such systems or cases where patterns don't persist (other than the stock market which is already known).

Thanks.
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Re: Why past performance does not predict future?

Post by carolinaman » Sat Mar 23, 2019 9:20 am

get_g0ing wrote:
Fri Mar 22, 2019 11:02 pm
When it comes to stocks or stock market, why is it said that past performance does not predict future performance?

Whereas in most areas of life, that does appear to be the case:

- In sports, the performance is not random. Good players tend to perform good.
- In education, a 4.0 GPA in one semester, doesn't get 2.0 in the next.
- In job hiring, companies actually say "past performance is a good indicator of future performance". So they look at internships, past work, etc.
- Companies that produce reliable cars like Toyota, Honda, keep producing reliable cars. It doesn't vary much year to year.

Thanks for answering.
Past performance does not (absolutely) predict the future is a true statement, but it is often used with a misleading context. Toyota and Honda do produce reliable cars most of the time but not always. Athletes with a history of superior performance do have off years. Mutual funds that have a long history of high performance are likely to continue to have high performance but do have off years. Also, when certain parameters change, i.e. new fund manager, change in fund objectives, dramatic growth of fund, then there is greater likelihood that fund performance might change. That is one reason to invest in index funds, there is more consistency and you do not have to worry about all of these variables.

Past performance does not guarantee future performance, but IMO, all things equal in the uncertain investment world, it is a better predictor of performance than most others. Fund costs is probably the greater predictor of future performance.

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Re: Why past performance does not predict future?

Post by Beliavsky » Sat Mar 23, 2019 9:59 am

get_g0ing wrote:
Fri Mar 22, 2019 11:02 pm
When it comes to stocks or stock market, why is it said that past performance does not predict future performance?

Whereas in most areas of life, that does appear to be the case:

- In sports, the performance is not random. Good players tend to perform good.
The performance football teams is not random, and when a team with record 7-1 plays a team with record 1-7, the former team usually wins. But the favored team has only about a 50% chance of covering the spread, since bookies are not dumb. Since stock analysts are not dumb, highly profitable companies have about the same chance of beating expectations as companies that have done poorly in the past few years. Stock returns depend on performance relative to market expectations.

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Re: Why past performance does not predict future?

Post by arcticpineapplecorp. » Sat Mar 23, 2019 10:08 am

even if players don't get injured (as one poster mentioned) Michael Jordan got older so is he able to play on the same level today that he did when he was in his 20s and 30s? Of course not. You wouldn't say his past performance in his 20s-30s predicts his future performance on the court in his 80s and 90s, would you?

maybe you're not aware of the myth of the "hot hand":

https://www.google.com/search?client=fi ... e+hot+hand

I have a co-worker who is big on sports and I explained this to him and yet he refused to believe it. So despite the best research, math, etc to dispute myths...people keep on believing them.

With regard to the stock market, there's many variables involved. Today the risk free rate of return is much lower than hisorically so. Would you expect the same return for bonds today as before when they paid 4.5% interest? No.

There's also the short term vs. long term. You could say over the very long term stocks could earn 8%-10% on average, but this may not be true for shorter periods of time (remember 2000-2009, lost decade?). So you can't say that just because "on average" stocks double about every 10 years (would require 7.2% per year compounding) that will happen with certainty or over every single 10 year period. There's just too much variability, like interest rates, p/e, whether we're entering or coming out of recession, etc.
"May you live as long as you want and never want as long as you live" -- Irish Blessing | "Invest we must" -- Jack Bogle

sambb
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Re: Why past performance does not predict future?

Post by sambb » Sat Mar 23, 2019 10:41 am

Japan is an example from 80s to 2000s.
World events can affect stock market for hundreds of years - pestilinece (plague, population decline) or war - nuclear for example
Past performance cannot predict the future. Tragic world events - Did anyone think skyscrapers in the USA are safe from being reduced to rubble? Lots of examples.

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Re: Why past performance does not predict future?

Post by JackoC » Sat Mar 23, 2019 10:51 am

Beliavsky wrote:
Sat Mar 23, 2019 9:59 am
get_g0ing wrote:
Fri Mar 22, 2019 11:02 pm
When it comes to stocks or stock market, why is it said that past performance does not predict future performance?

Whereas in most areas of life, that does appear to be the case:

- In sports, the performance is not random. Good players tend to perform good.
The performance football teams is not random, and when a team with record 7-1 plays a team with record 1-7, the former team usually wins. But the favored team has only about a 50% chance of covering the spread, since bookies are not dumb. Since stock analysts are not dumb, highly profitable companies have about the same chance of beating expectations as companies that have done poorly in the past few years. Stock returns depend on performance relative to market expectations.
Good point. Stock returns are all about future performance compared to the expectations embedded in today's prices. That's the fundamental difference between them and innumerable cases where underlying performance is somewhat predictable. It's somewhat predictable that Golden State will be a formidable challenger for the NBA title during the remaining peak careers of its major players. Although it's not certain, subject to injuries or chemistry/contract issues. It's somewhat predictable that Apple will produce tech products huge numbers of people want to buy for much more than it costs Apple to make them, as it has. Although it's not certain. It's somewhat predictable that Toyota will produce vehicles of relatively high reliability relative to the prevailing standard, albeit not at wide profit margins, as it has. Though it's also not certain. But the chance of successfully betting on Golden State or the future return of either stock is basically unrelated to the predicable element of future performance since that's already factored into the pricing to extent the market for sports bets or stocks is efficient.

The same thing is true of the stock market as a whole. The individual idiosyncratic risks of Apple, Toyota, etc* few 1000 wash out, but the whole market's future performance is likewise unrelated to stuff like 'profits are high' because that's already reflected in the price. We can gain insight into *expected* market return though by seeing how the price relates to metrics like earnings, book value, profit as % of GDP, bond yields and so forth. From which we'd rationally conclude stock expected returns now are lower than stock realized returns historically. That says nothing about companies performing worse in their businesses than previously, it's all about the starting price. It's an ironclad relationship that a higher price on bonds of a given coupon means a lower yield. That concept applies in a fuzzier way to stocks, but it still applies. It's illogical to treat stocks as a magic asset where valuation and expected return are somehow unrelated. That contradiction is especially apparent if comparing them to risky bonds. Virtually nobody maintains that lower yields on junk bonds nowadays must 100% strictly reflect lower expected default losses. Everybody recognizes that the risk premium on junk bonds can also be lower (or higher) than whatever it happened to be in the past, on top of an undeniably lower than historical 'riskless' return available on capital in the govt bond market (though notably higher for US govt bonds than some other rich countries).

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Re: Why past performance does not predict future?

Post by warner25 » Sat Mar 23, 2019 11:41 am

Beliavsky wrote:
Sat Mar 23, 2019 9:59 am
The performance football teams is not random, and when a team with record 7-1 plays a team with record 1-7, the former team usually wins. But the favored team has only about a 50% chance of covering the spread, since bookies are not dumb. Since stock analysts are not dumb, highly profitable companies have about the same chance of beating expectations as companies that have done poorly in the past few years. Stock returns depend on performance relative to market expectations.
Excellent way to make the point I was trying make with a lot more words.

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Re: Why past performance does not predict future?

Post by MotoTrojan » Sat Mar 23, 2019 11:46 am

Amazon is a very powerful company and growing faster than almost anything else. It may be safe to say that Amazon will continue “getting a 4.0” but in order for its stock to keep performing as it has, Amazon actually has to beat expectations, not maintain them.

This is the fundamental difference. Everyone knows who the “smart students” are in the market and thus can assign a higher multiple to brighter ones by driving their price up.

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Re: Why past performance does not predict future?

Post by gmaynardkrebs » Sat Mar 23, 2019 12:07 pm

Stocks follow a random walk. "News" is by definition non-predictable. Not merely "unpredictable", non-predictable.

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Re: Why past performance does not predict future?

Post by Fallible » Sat Mar 23, 2019 1:30 pm

get_g0ing wrote:
Sat Mar 23, 2019 1:05 am
Fallible wrote:
Fri Mar 22, 2019 11:26 pm
get_g0ing wrote:
Fri Mar 22, 2019 11:02 pm
When it comes to stocks or stock market, why is it said that past performance does not predict future performance?

Whereas in most areas of life, that does appear to be the case:

- In sports, the performance is not random. Good players tend to perform good.
- In education, a 4.0 GPA in one semester, doesn't get 2.0 in the next.
- In job hiring, companies actually say "past performance is a good indicator of future performance". So they look at internships, past work, etc.
- Companies that produce reliable cars like Toyota, Honda, keep producing reliable cars. It doesn't vary much year to year.

Thanks for answering.
Nobody can predict the future with certainty, including your examples.
That's true, but even without absolute certainty it's extremely useful ... the evidence is in how people actually behave in the real world. If someone is looking for a reliable car, for instance, they will pick Honda or Toyota (or another with high past reliability). They will not think: since certainty is not possible, I'll just pick randomly.
Since the future can't be predicted with any certainty, the usefulness of such predictions would more likely range from limited (as one poster noted here, investment fees would be far more important) to downright misleading.

Also, I agree with other posters here who have said the standard phrase is "guarantee" future performance, or "absolutely predict" it. Anything can be predicted, but not with guaranteed accuracy.

And I agree that most people probably will not think "since certainty is not possible, I'll just pick randomly." But these would more likely be unconscious thoughts that they are not aware of, but that can figure prominently in their behavior.
"John Bogle has changed a basic industry in the optimal direction. Of very few can this be said." ~Paul A. Samuelson

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Re: Why past performance does not predict future?

Post by 2015 » Sat Mar 23, 2019 2:35 pm

get_g0ing wrote:
Sat Mar 23, 2019 1:00 am
magicrat wrote:
Fri Mar 22, 2019 11:17 pm
Please provide some examples of highly volatile systems where the patterns persist.
Hi,
I don't know what you mean by volatile systems. Can you share examples of such systems or cases where patterns don't persist (other than the stock market which is already known).

Thanks.
Our very lives. People forget this all of the time. This is why much of what you read related to investing, personal finance, and microeconomics is silly because it treats these areas as sterile environments devoid of human consideration. Humans live in a complex adaptive system involving (among many other things) their own unconscious motivations which no investment study will ever be able to satisfactorily capture.

Knowing thyself and thine own personal system (historical and otherwise) is verily more important than chasing the chillinest portfolio and most clever strategy.

alex_686
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Re: Why past performance does not predict future?

Post by alex_686 » Sat Mar 23, 2019 2:51 pm

There is a difference between a good company and a good stock.
get_g0ing wrote:
Fri Mar 22, 2019 11:02 pm
- In sports, the performance is not random. Good players tend to perform good.
Are the Yankees a good baseball team? Yes. Will they have a winning season in 2019, winning more than 81 games? Probably. So let us call them a good company.

But are they a good bet? A good stock? I will point out that their over/under odds are 96.5. Knowing that they are a superior team is not sufficient - everybody knows that. It is already baked into the odds. If you are going to make money betting on the Yankees you are going to need superior skill and information.

Same thing with Honda & Toyota. Making great products does not mean a good stock price. That product excellence is already baked in.

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Matigas
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Re: Why past performance does not predict future?

Post by Matigas » Sat Mar 23, 2019 3:02 pm

I like how people use past performance to prove past performance is irrelevant.

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gmaynardkrebs
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Re: Why past performance does not predict future?

Post by gmaynardkrebs » Sat Mar 23, 2019 3:40 pm

The SEC rule "past performance does not guarantee future results" is one of the more disgraceful examples of regulatory capture. It vastly understates the the lack of relevance between past returns and future returns. The sole beneficiary has been the mutual fund industry.

chevca
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Re: Why past performance does not predict future?

Post by chevca » Sat Mar 23, 2019 3:41 pm

get_g0ing wrote:
Fri Mar 22, 2019 11:02 pm
When it comes to stocks or stock market, why is it said that past performance does not predict future performance?

Whereas in most areas of life, that does appear to be the case:

- In sports, the performance is not random. Good players tend to perform good.
- In education, a 4.0 GPA in one semester, doesn't get 2.0 in the next.
- In job hiring, companies actually say "past performance is a good indicator of future performance". So they look at internships, past work, etc.
- Companies that produce reliable cars like Toyota, Honda, keep producing reliable cars. It doesn't vary much year to year.

Thanks for answering.
Until they don't...

Sports stars go along strong until one year age catches up with them and they fall off. Could be age 30, or 35, or 40... who knows?

A 4.0 student goes along great until they start hanging out with the wrong crowd, get into partying, and all of a sudden they're a 2.0 student.

Ask anyone that hires people if they've ever gotten it wrong basing a hire off past performance and the person didn't work out with the company for whatever reason.

I guess you have missed all the recent Honda CRV trouble threads.

I don't think your examples fly any better than why one should not base the market on past performance. You never know when the good times are going to end.

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Re: Why past performance does not predict future?

Post by yohac » Sat Mar 23, 2019 3:50 pm

get_g0ing wrote:
Fri Mar 22, 2019 11:02 pm
When it comes to stocks or stock market, why is it said that past performance does not predict future performance?

Whereas in most areas of life, that does appear to be the case:

- In sports, the performance is not random. Good players tend to perform good.
- In education, a 4.0 GPA in one semester, doesn't get 2.0 in the next.
- In job hiring, companies actually say "past performance is a good indicator of future performance". So they look at internships, past work, etc.
- Companies that produce reliable cars like Toyota, Honda, keep producing reliable cars. It doesn't vary much year to year.

Thanks for answering.
In your examples, the person or company has direct control over their "performance". A fund manager has no direct control over stock prices.

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Phineas J. Whoopee
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Re: Why past performance does not predict future?

Post by Phineas J. Whoopee » Sat Mar 23, 2019 5:20 pm

You've hit upon one of the misunderstandings about investing.

Unless you directly control the company, you can't count on investments to go up, down, or sideways. Even if you do directly control it the company is subject to pressures outside its influence.

In most situations working longer and harder can make more money. In individual investing it doesn't. In most situations a growing business grows, until it doesn't.

In our individual-investor lives the approach is to spend as little as possible in fees while collecting the market's total return (which over any period of time may be negative).

PJW

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Re: Why past performance does not predict future?

Post by get_g0ing » Sun Mar 24, 2019 8:42 am

newinvestor54 wrote:
Sat Mar 23, 2019 6:53 am
It's because the stock market is dynamic and based on expectations -- so getting outsized future returns means that you have to find stocks that continue to beat expectations. The appropriate analogies would not be that a good baseball player or student continues to be good, but that they keep performing better than anyone expects. Once the expectations change ,the good performance is "priced in" and it's harder to keep exceeding that in the future and easier to fall short.
warner25 wrote:
Sat Mar 23, 2019 8:47 am
newinvestor54 wrote:
Sat Mar 23, 2019 6:53 am
It's because the stock market is dynamic and based on expectations -- so getting outsized future returns means that you have to find stocks that continue to beat expectations. The appropriate analogies would not be that a good baseball player or student continues to be good, but that they keep performing better than anyone expects. Once the expectations change ,the good performance is "priced in" and it's harder to keep exceeding that in the future and easier to fall short.
Great answer; I was thinking along the same lines. To expand on this a bit:

I think the answer is the Efficient Market Hypothesis. Essentially, the analogies are wrong because they look only at the value of things and ignore their prices.

Sports teams, limited by funds or a league-imposed salary cap, don't just care how good a player is; they care how good the player is relative to how much he'll cost to sign. When everybody knows the player is good based on his past performance, salary expectations go up. Any company hiring employees needs to do the same. Lots of people argue that a Toyota is more reliable than a Kia based on past performance, but a consumer needs to ask whether a Toyota is worth the premium over a Kia.

These markets exhibit varying degrees of efficiency. Financial markets seem to be very efficient, hence EMH. So as an investor, it's not helpful to know that a company is good when the market has already priced the company's stock accordingly. EMH says (very simply summarizing here) that trying to exploit inefficiencies by very carefully picking stocks of good companies that appear to be mispriced is about as successful as picking stocks at random. So the performance of a stock or mutual fund relative to a similar stocks or mutual funds in the same category over any period of time is random, and subsequent periods of time are unpredictable.

Where past performance seems to be useful is seeing how various types or classes of assets perform relative to each other. For example, we see that stocks are more volatile than bonds which seems to explain a persistent equity risk premium. Or we see that when when stocks go down, bonds often go up. For lack of a better method, I think long-term past performance of broad, global markets also helps us get in the ballpark of how much we need to save and invest to reach our goals.

Beliavsky wrote:
Sat Mar 23, 2019 9:59 am
get_g0ing wrote:
Fri Mar 22, 2019 11:02 pm
When it comes to stocks or stock market, why is it said that past performance does not predict future performance?

Whereas in most areas of life, that does appear to be the case:

- In sports, the performance is not random. Good players tend to perform good.
The performance football teams is not random, and when a team with record 7-1 plays a team with record 1-7, the former team usually wins. But the favored team has only about a 50% chance of covering the spread, since bookies are not dumb. Since stock analysts are not dumb, highly profitable companies have about the same chance of beating expectations as companies that have done poorly in the past few years. Stock returns depend on performance relative to market expectations.
JackoC wrote:
Sat Mar 23, 2019 10:51 am
Beliavsky wrote:
Sat Mar 23, 2019 9:59 am
get_g0ing wrote:
Fri Mar 22, 2019 11:02 pm
When it comes to stocks or stock market, why is it said that past performance does not predict future performance?

Whereas in most areas of life, that does appear to be the case:

- In sports, the performance is not random. Good players tend to perform good.
The performance football teams is not random, and when a team with record 7-1 plays a team with record 1-7, the former team usually wins. But the favored team has only about a 50% chance of covering the spread, since bookies are not dumb. Since stock analysts are not dumb, highly profitable companies have about the same chance of beating expectations as companies that have done poorly in the past few years. Stock returns depend on performance relative to market expectations.
Good point. Stock returns are all about future performance compared to the expectations embedded in today's prices. That's the fundamental difference between them and innumerable cases where underlying performance is somewhat predictable. It's somewhat predictable that Golden State will be a formidable challenger for the NBA title during the remaining peak careers of its major players. Although it's not certain, subject to injuries or chemistry/contract issues. It's somewhat predictable that Apple will produce tech products huge numbers of people want to buy for much more than it costs Apple to make them, as it has. Although it's not certain. It's somewhat predictable that Toyota will produce vehicles of relatively high reliability relative to the prevailing standard, albeit not at wide profit margins, as it has. Though it's also not certain. But the chance of successfully betting on Golden State or the future return of either stock is basically unrelated to the predicable element of future performance since that's already factored into the pricing to extent the market for sports bets or stocks is efficient.

The same thing is true of the stock market as a whole. The individual idiosyncratic risks of Apple, Toyota, etc* few 1000 wash out, but the whole market's future performance is likewise unrelated to stuff like 'profits are high' because that's already reflected in the price. We can gain insight into *expected* market return though by seeing how the price relates to metrics like earnings, book value, profit as % of GDP, bond yields and so forth. From which we'd rationally conclude stock expected returns now are lower than stock realized returns historically. That says nothing about companies performing worse in their businesses than previously, it's all about the starting price. It's an ironclad relationship that a higher price on bonds of a given coupon means a lower yield. That concept applies in a fuzzier way to stocks, but it still applies. It's illogical to treat stocks as a magic asset where valuation and expected return are somehow unrelated. That contradiction is especially apparent if comparing them to risky bonds. Virtually nobody maintains that lower yields on junk bonds nowadays must 100% strictly reflect lower expected default losses. Everybody recognizes that the risk premium on junk bonds can also be lower (or higher) than whatever it happened to be in the past, on top of an undeniably lower than historical 'riskless' return available on capital in the govt bond market (though notably higher for US govt bonds than some other rich countries).
MotoTrojan wrote:
Sat Mar 23, 2019 11:46 am
Amazon is a very powerful company and growing faster than almost anything else. It may be safe to say that Amazon will continue “getting a 4.0” but in order for its stock to keep performing as it has, Amazon actually has to beat expectations, not maintain them.

This is the fundamental difference. Everyone knows who the “smart students” are in the market and thus can assign a higher multiple to brighter ones by driving their price up.
I believe these responses have exposed the flaw in my thinking. :beer

Good explanations.

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Re: Why past performance does not predict future?

Post by get_g0ing » Sun Mar 24, 2019 8:51 am

newinvestor54 wrote:
Sat Mar 23, 2019 6:53 am
It's because the stock market is dynamic and based on expectations -- so getting outsized future returns means that you have to find stocks that continue to beat expectations. The appropriate analogies would not be that a good baseball player or student continues to be good, but that they keep performing better than anyone expects. Once the expectations change ,the good performance is "priced in" and it's harder to keep exceeding that in the future and easier to fall short.
After thinking on your reply, I have a question:
So why is this not true for the whole market overall? If we all expect the market to keep going up, why is this expectation not "priced in", and why the whole market is able to continually beat expectations?

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Re: Why past performance does not predict future?

Post by get_g0ing » Sun Mar 24, 2019 8:55 am

acegolfer wrote:
Sat Mar 23, 2019 7:25 am
I'll use middle school stats to explain this. In all your cases, the outcome is still random. Nevertheless, we can predict with some accuracy because its stdev is much smaller than the expected value.

OTOH, for stock returns, the stdev is 2-10 times higher than the expected value. This makes prediction practically impossible.
Hi, thanks for replying. I would like to understand what you mean, how is the outcome random in my example? I assume random to mean close to 50-50 change like a coin flip. But if we have a 4.0 student for a few semesters, I don't think the probability of her getting 4.0 next semester would be 50-50 like a coin toss. Maybe I didn't understand.

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Re: Why past performance does not predict future?

Post by get_g0ing » Sun Mar 24, 2019 9:10 am

arcticpineapplecorp. wrote:
Sat Mar 23, 2019 10:08 am
maybe you're not aware of the myth of the "hot hand":
Just a side note, it appears that the hot hand fallacy is itself a fallacy :)
https://papers.ssrn.com/sol3/papers.cfm ... id=2627354

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Re: Why past performance does not predict future?

Post by get_g0ing » Sun Mar 24, 2019 9:16 am

2015 wrote:
Sat Mar 23, 2019 2:35 pm
Knowing thyself and thine own personal system (historical and otherwise) is verily more important than chasing the chillinest portfolio and most clever strategy.
If you can explain more what you mean and how, I'd be interested in reading. Thanks.

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get_g0ing
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Re: Why past performance does not predict future?

Post by get_g0ing » Sun Mar 24, 2019 9:17 am

alex_686 wrote:
Sat Mar 23, 2019 2:51 pm
There is a difference between a good company and a good stock.
get_g0ing wrote:
Fri Mar 22, 2019 11:02 pm
- In sports, the performance is not random. Good players tend to perform good.
Are the Yankees a good baseball team? Yes. Will they have a winning season in 2019, winning more than 81 games? Probably. So let us call them a good company.

But are they a good bet? A good stock? I will point out that their over/under odds are 96.5. Knowing that they are a superior team is not sufficient - everybody knows that. It is already baked into the odds. If you are going to make money betting on the Yankees you are going to need superior skill and information.

Same thing with Honda & Toyota. Making great products does not mean a good stock price. That product excellence is already baked in.
Like some of the replies I quoted above, I believe this is the true answer to why my hypothetical thinking was wrong.

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Re: Why past performance does not predict future?

Post by get_g0ing » Sun Mar 24, 2019 9:20 am

gmaynardkrebs wrote:
Sat Mar 23, 2019 3:40 pm
The SEC rule "past performance does not guarantee future results" is one of the more disgraceful examples of regulatory capture. It vastly understates the the lack of relevance between past returns and future returns. The sole beneficiary has been the mutual fund industry.
I did not understand at all, sorry. Can you explain or paraphrase what you mean in other words please?

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Re: Why past performance does not predict future?

Post by alex_686 » Sun Mar 24, 2019 9:35 am

get_g0ing wrote:
Sun Mar 24, 2019 8:51 am
After thinking on your reply, I have a question:
So why is this not true for the whole market overall? If we all expect the market to keep going up, why is this expectation not "priced in", and why the whole market is able to continually beat expectations?
The formal theory is "Equity.Risk Premium", which ties into Beta.

The theory goes that we have a choice of either investing in a safe asset (US Treasury) or a risky asset (stocks). The reason why I would invest in higher risk asserts is because of higher expected return. The higher the risk, the higher thhe expected return.

Take betting on a 7-1 team verse a 1-7 team. The 7-1 team is the favored team and is the better team. Betting on that team to win will result in a low payoff. Betting on the 1-7 team thus requires a high payoff to balance the odds.

I will point out that one of the best preforming stocks in 2017 was Best Buy, a case of a 1-7 team actually winning.

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Re: Why past performance does not predict future?

Post by gmaynardkrebs » Sun Mar 24, 2019 9:42 am

get_g0ing wrote:
Sun Mar 24, 2019 9:20 am
gmaynardkrebs wrote:
Sat Mar 23, 2019 3:40 pm
The SEC rule "past performance does not guarantee future results" is one of the more disgraceful examples of regulatory capture. It vastly understates the the lack of relevance between past returns and future returns. The sole beneficiary has been the mutual fund industry.
I did not understand at all, sorry. Can you explain or paraphrase what you mean in other words please?
Because stating that "past performance does not guarantee future results" and that you could lose money is something that the large majority of investors know already. Moreover, it arguably implies that there is a positive relationship between high past returns and high future returns--just not a guaranteed one. The reality is that high past returns are a poor predictor of high future returns.

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Re: Why past performance does not predict future?

Post by get_g0ing » Sun Mar 24, 2019 9:47 am

alex_686 wrote:
Sun Mar 24, 2019 9:35 am
get_g0ing wrote:
Sun Mar 24, 2019 8:51 am
After thinking on your reply, I have a question:
So why is this not true for the whole market overall? If we all expect the market to keep going up, why is this expectation not "priced in", and why the whole market is able to continually beat expectations?
The formal theory is "Equity.Risk Premium", which ties into Beta.

The theory goes that we have a choice of either investing in a safe asset (US Treasury) or a risky asset (stocks). The reason why I would invest in higher risk asserts is because of higher expected return. The higher the risk, the higher thhe expected return.

Take betting on a 7-1 team verse a 1-7 team. The 7-1 team is the favored team and is the better team. Betting on that team to win will result in a low payoff. Betting on the 1-7 team thus requires a high payoff to balance the odds.

I will point out that one of the best preforming stocks in 2017 was Best Buy, a case of a 1-7 team actually winning.
Very excellent. Thanks for talking the care to explain.

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Re: Why past performance does not predict future?

Post by get_g0ing » Sun Mar 24, 2019 9:48 am

gmaynardkrebs wrote:
Sun Mar 24, 2019 9:42 am
get_g0ing wrote:
Sun Mar 24, 2019 9:20 am
gmaynardkrebs wrote:
Sat Mar 23, 2019 3:40 pm
The SEC rule "past performance does not guarantee future results" is one of the more disgraceful examples of regulatory capture. It vastly understates the the lack of relevance between past returns and future returns. The sole beneficiary has been the mutual fund industry.
I did not understand at all, sorry. Can you explain or paraphrase what you mean in other words please?
Because stating that "past performance does not guarantee future results" and that you could lose money is something that the large majority of investors know already. Moreover, it arguably implies that there is a positive relationship between high past returns and high future returns--just not a guaranteed one. The reality is that high past returns are a poor predictor of high future returns.
I get what you mean now :)
Thank you for paraphrasing.

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Re: Why past performance does not predict future?

Post by MotoTrojan » Sun Mar 24, 2019 9:49 am

get_g0ing wrote:
Sun Mar 24, 2019 8:55 am
acegolfer wrote:
Sat Mar 23, 2019 7:25 am
I'll use middle school stats to explain this. In all your cases, the outcome is still random. Nevertheless, we can predict with some accuracy because its stdev is much smaller than the expected value.

OTOH, for stock returns, the stdev is 2-10 times higher than the expected value. This makes prediction practically impossible.
Hi, thanks for replying. I would like to understand what you mean, how is the outcome random in my example? I assume random to mean close to 50-50 change like a coin flip. But if we have a 4.0 student for a few semesters, I don't think the probability of her getting 4.0 next semester would be 50-50 like a coin toss. Maybe I didn't understand.
I think you understand now but the reward for guessing correctly that a former 4.0 student will get another 4.0 is low since they have a higher P/E. Now if they go on to win the Nobel prize in astrophysics...

Companies can both earn $1 a year (the company, not your stock) but Amazon can be $80 a share and Best Buy something like $13 (can’t recall exact P/E). Amazon is a 4.0 so you better hope they get up to $7 someday or you’d have done better with Best Buy.

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Re: Why past performance does not predict future?

Post by gmaynardkrebs » Sun Mar 24, 2019 9:50 am

alex_686 wrote:
Sun Mar 24, 2019 9:35 am
Take betting on a 7-1 team verse a 1-7 team. The 7-1 team is the favored team and is the better team. Betting on that team to win will result in a low payoff. Betting on the 1-7 team thus requires a high payoff to balance the odds.
In a fair game, isn't the risk adjusted return the same in this case? If your analogy is correct, then stocks should pay exactly the same as safe assets over the long run.

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Re: Why past performance does not predict future?

Post by Tyler9000 » Sun Mar 24, 2019 9:53 am

carolinaman wrote:
Sat Mar 23, 2019 9:20 am
Past performance does not (absolutely) predict the future is a true statement, but it is often used with a misleading context. Toyota and Honda do produce reliable cars most of the time but not always. Athletes with a history of superior performance do have off years.
Exactly. You're getting at the underlying issue of the difference between predictive precision and measurable uncertainty.

It's true that you cant just look at a single historical average or recent 10-year period and assume that it will be the same for you in the next 10 years, as investing involves a certain amount of inherent uncertainty. But it's not true that all investments are equally uncertain. For example, it's anyone's guess how a portfolio of 100% emerging market stocks will perform over the next 10 years. But 100% 3-month T-Bills? I bet we could estimate that outcome within a pretty tight range of error.

So the trick with past performance is to stop trying to use it to predict the precise flight path of the next shot. Stick to using the numbers to identify an accurate shooter that is more likely than not to hit the target even accounting for uncertainty, and IMHO it can be quite useful.

Uncertainty is a tricky concept to understand, but if you're interested in more on this including some helpful visuals, read this:

When Aiming for a Target Consider the Accuracy of the Weapon
Last edited by Tyler9000 on Sun Mar 24, 2019 9:55 am, edited 1 time in total.

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