2011’s Top Ten (Part 3)

Resolution number three in terms of financial planning is to think forward, not backward.

You’ve read and heard the disclaimers before: “Past performance does not necessarily indicate future results.” And it’s true. Funds or stocks that are amazing performers rarely repeat those results year after year. But even though we know this to be true, we still behave like it isn’t.

That’s because we’re wired to believe differently. The best sports teams seem to repeat their success. The best places to hunt or fish remain the best places season after season. So why isn’t this true in the markets? It’s because economic success tends to sow the seeds of its own destruction, and failure contains the germ of its own resurrection. If a company finds a way to achieve an excessive return, they will soon have competitors who force down margins, leading to more normal returns. Similarly, sectors that have extremely narrow margins will likely see firms leave that line of business, allowing margins to recover.

This up-and-down-and-up behavior in economics and investing is what makes it so challenging. But it’s why you need to plan looking forwards, not backwards. You should determine how much to put into stocks, bonds, and cash by looking at what the markets are likely to do in the future, not what they’ve done in the recent past. This doesn’t change the economic truths of how stocks capture growth, bonds claim cash, and real-estate captures rents. But it’s also true that what goes up comes down and what goes down comes back up.

Knowing how to ride this roller-coaster is part of what having a plan is for. Because when it comes to investing, experience isn’t always the best teacher.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

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