A popular piece of advice for investors is that “past performance does not guarantee future results.” While most long-time clients are probably well aware of this, a report from Financial Advisor IQ
points out another expectation that advisors need to manage.
Referring to a note from research firm Morningstar, the piece points out how clients approaching retirement tend to go after hot investments without regard for their long-term performance history. Recency bias – “the tendency to remember events from the recent past more clearly than those from further back,” as defined in the report – affects people’s judgment, especially when they’re trying to catch up to a looming retirement fund target.
Some investors may chase after products that have exhibited superior recent performance, without realizing they are likely to correct downward based on a consideration of their entire history. The most recent example, Morningstar wrote, was in the US real estate market between 2003 and 2007, when many investors refused to accept that bear markets can also happen.
Therefore, financial advisors have to be ready to take the blinders off their clients. In other words, advisors have to be able to show the longer-term view. Morningstar suggested the use of the Callan Periodic Table of Investment Returns
, which illustrates the performance of key indices like the S&P 500 and the Russell 2000.
The chart was actually developed to illustrate the importance of diversification, but in this case, it can be useful in showing how what comes up must also come down.
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