You have probably heard investment advisers and fund managers state the mantra: “Past returns are no guarantee of future performance.”

But in a world without reliable crystal balls, investors and commentators still often turn to past returns to compare fund managers and funds, and predict future outcomes, to an extent.

So how important are past returns as an indicator, and what other tools might you use to guide an investment decision?

What’s the problem with past returns?

There is ample data available to investors showing how various funds and individual investment assets have performed.

Share market data can show how a share price moved over any set period of time, and regular reports show fund manager performance over the month, quarter, year and decade.

Problems can arise because humans have a tendency to look for patterns and assume that was has happened in the past will continue. But sometimes a fund or investment is doing well because of market conditions that will not last, or which might be more volatile in future if the macroeconomic environment changes. The more concentrated the investment, the more likely this could be.

Blip or pattern?

Past returns can be more useful when they are used to show a pattern, rather than a short-term movement.

Investment data provider Morningstar often recommends that investors look at returns over a longer period of time, such as 10 years, to get a sense of which fund managers have a pattern of delivering good returns, or even beating the market regularly.

Over this longer time period you can often see which fund managers are generally among the top of the pack and which are nearer the bottom, which is usually a better guide than the vagaries of only comparing returns over the last year or two.

Not just good news

When we talk about projecting from past returns, we often mean that investors may overestimate future performance.

But there is equally the chance that investors could miss out on strong returns because an investment has been through a difficult period.

As Ryan Dooyema of Russell Investments points out, investors should not discount an investment simply because it has done poorly recently, particularly if that is due to wider macroeconomic trends or market conditions.

What else can be used?

If you’re not looking at past performance to guide you, what are the alternatives?

Depending on the investment, there are a few factors to consider.

• The people managing the money or the investment, and their track record.
• The level of diversification in the investment and in your portfolio – very concentrated investments are likely to experience much larger movement in returns than diversified investments, and portfolio diversification can be used to smooth the returns overall.
• Returns compared to fees – active managers tend to be more expensive than passive managers but should be able to demonstrate that investors are receiving value in return.
• Fund performance according to relevant benchmark.
• Alignment with investor beliefs and concerns.

One of the biggest deciding factors is likely to be your own goals and risk appetite. Finding an investment that fits with your personal circumstances is a key part of any investment plan. Our advisers can help you to determine your options, and what might be suitable.

Ready to talk?

If you would like expert advice on your investment portfolio, or just a check-up to determine whether you are on track, get in touch. Our team of SHARE advisers have more than $300 million in client funds under management and nearly 1600 years’ combined experience. Phone us on 0508 2 SHARE or find us at sharenz.com

Disclaimer: Please note that the content provided in this article is intended as an overview and as general information only. While care is taken to ensure accuracy and reliability, the information provided is subject to continuous change and may not reflect current developments or address your situation. Before making any decisions based on the information provided in this article, please use your discretion and seek independent guidance.