Enrich Your Future 13: Past Performance Is Not a Predictor of Future Performance

In this episode of Enrich Your Future, Andrew and Larry Swedroe discuss Larry’s new book, Enrich Your Future: The Keys to Successful Investing. In this series, they discuss Chapter 13: Between a Rock and a Hard Place.

LEARNING: Past performance is not a strong predictor of future performance.

“If you must invest actively, find active funds that design their strategies more intelligently to take advantage of the problems and at least avoid pitfalls.”

Larry Swedroe

In this episode of Enrich Your Future, Andrew and Larry Swedroe discuss Larry’s new book, Enrich Your Future: The Keys to Successful Investing. The book is a collection of stories that Larry has developed over 30 years as the head of financial and economic research at Buckingham Wealth Partners to help investors. You can learn more about Larry’s Worst Investment Ever story on Ep645: Beware of Idiosyncratic Risks.

Larry deeply understands the world of academic research and investing, especially risk. Today, Andrew and Larry discuss Chapter 13: Between a Rock and a Hard Place.

Chapter 13: Between a Rock and a Hard Place

In this chapter, Larry illustrates why past performance is not a strong predictor of future performance.

Academic research has found that prominent financial advisors, investment policy committees, and pension and retirement plans engage top academic practitioners to help them identify future managers who will outperform the market. Such entities only hire managers with a track record of outperforming. They analyze their performance to see if it is statistically significant.

However, research also shows that, on average, the active managers chosen based on outstanding track records have failed to live up to expectations. The underperformance relative to passive benchmarks invariably leads decision-makers to fire the active manager. And the process begins anew.

A new round of due diligence is performed, and a new manager is selected to replace the poorly performing one. And, almost invariably, the process is repeated a few years later. So whenever pension plans interview Larry and he notices this hiring pattern, he always asks them what their hiring process is and what they’re doing differently this time since, you know, the same process failed persistently, causing regular turnover of managers. Nobody has ever answered that question.

According to Larry, many individual investors go through the same motions of picking a manager and end up with the same results—a high likelihood of poor performance.

Doing the same thing over and over expecting a different result is insanity

Larry observes that the conventional wisdom that past performance is a strong predictor of future performance is so firmly ingrained in our culture that it seems almost no one stops to ask if it is correct, even in the face of persistent failure. Larry wonders why investors aren’t asking themselves: “If the process I used to choose a manager that would deliver outperformance failed, and I use the same process the next time, why should I expect anything but failure the next time?”

The answer is painfully apparent. If you don’t do anything different, you should expect the same result. Yet, so many investors do not ask this simple question.

Larry insists that it is essential to understand that neither the purveyors of active management nor the gatekeepers want you to ask that question. If you did, they would go out of business. You, on the other hand, should ask that question. You must provide the best returns to yourself or to members of the plan for which you are a trustee, not to