investment: In personal finance, past performance is not an indicator of future: How to make an informed investment decision

I should not have quit my job, she lamented for the tenth time. We had been speaking only for a little over an hour. She described in great detail how successful she was, and how accomplished and appreciated she was at work. And then she gave it up as she took ill. I did not ask the one question that was running in my head: but what stopped you for the 15 years since then after you became better? I was being nice.

But her voice remained in my head. How many of us live in the past! We can’t brush it aside easily. So many of us routinely like to reorder our lives, by rearranging some blocks in the past. If only I had studied this rather than that; or taken this job over that; or lived in this city than that. And so on. We make choices. All the time. It is unfair to ourselves if we went back and questioned that, because we can only choose one among the many choices we had then. That is how it is.

There is a mirage at play. The successful lives of accomplished people are portrayed gloriously in public. Many believe it is inspirational to know these stories. Only partly, I think. Where one stands today is known. And then we go back to fit a template on all those correct choices that person may have made. As if those were the only choices they had. How biased is that!

At every turn, one will face choices. Many of them will fail to deliver. A few will turn out to be right. And catapult one to fame. We selectively look at those things that went right. We make it look like those were the specific deliberate choices. As if those steps to success were so well known and so well laid out. Nope. Enough fumbling happens. Except that those stories that did not end well do not get that much attention and analysis.

The problem with these generalisations of success is not just this selective bias. But a dangerous oversimplification of decision making itself. Most like to believe that a path to success can be specified. We discard the reality that at every turn a choice was made, and that choice had the high probability of failing. We dislike the word luck, and we attribute success to deliberate choices, not made serendipitously but presciently.

Investing is tough for this reason. We choose a stock, a bond, a fund, a property or whatever else we like to invest in. If it turns out to be good, we are pleased with ourselves. We may have cracked the code, we think. It turns out to be bad, we look at all those choices we did not make, and are ridden with guilt. IPOs get routinely overpriced while being offered and underperformed after listing because we suffer this bias.

We miss a winning IPO and we tell ourselves that the only way to make good that loss, is to buy the next one. The next one will be priced high given this line of eager investors. Poorer and poorer issues will begin to hit the market, because investors are fitting one template for every IPO that comes in. So much so that many will swear that one cannot lose money in an IPO— it must list high.

Data does not support this belief, however popular it may be. The good ones are but rare; the bad and ugly are too many; and investors cannot tell. The other extreme reaction to this fiasco is another set of investors who will keep away from IPOs completely. They will have nothing to do with this game, for they believe there is no money to be made. Caught in the middle are the experts who must rate and rank the IPOs and make recommendations. They fumble along and get some right and most wrong, and since people forget, everything is alright.

We simply cannot deal with regret. We deny; we justify; we blame. Sheena Iyengar wrote years ago that the presence of too many choices makes decision making difficult for the human brain. The irony is that people don’t like it if there aren’t many choices; greater the number of choices, less the likelihood people will make decisions easily.

Is there a template for investing in equity, people ask. There must be something that helps choose the right stocks to invest in. While most of the world believed stock markets were a wild speculation or a costly gamble, Benjamin Graham showed the path in 1934. He propounded what we now know as fundamental analysis. Stock prices are driven by underlying merit, he said, bestowing nobility on a much maligned profession.

In the years since then, people have toyed with every trick other than the sheer hard work and intensive analysis that Graham proposed. There is still no fail proof template; but there is a solid approach to picking stocks. The hard work of understanding the business, analyzing the numbers, evaluating the managers and making a judgment. Nowhere is this a prediction. A judgment is only as strong as the information it is based upon.

The best stock pickers understand that they may have missed something; that something might change which they failed to evaluate adequately. They therefore remain humble; they remain willing to be proven wrong; they know that new information can change every assumption of theirs. That is why they dont look at the past to join the dots and make a template; they work dynamically and are tuned to the future.

This approach is tough. It takes courage to make a decision and to evaluate it dynamically and make course corrections on the fly. What can simple folks do?

We can work within our context and means to remain focused on the present. We can imagine a future we desire and do our best with those assumptions. We can remain dynamic and humble. My friend who quit her job can realise that her regret means nothing; she can begin anew to do something else that will enable her to accomplish more.

Sometimes we fail to see that the past doesn’t matter as much as we give it credit for. In personal finance, past performance is not an indicator of the future. And that is a good thing, no?

(The writer is Chairperson, Center for Investment Education and Learning.)


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