Have you ever dreamed about what it would be like to have the ability to foresee the future? Just think about the possibilities. Imagine if at December 31st of every year, we knew what the best investment for the following year would be. We would be millionaires in no time at all!
A recent article in the Economist told the story of Felicity Foresight, a woman gifted with the ability to see the future. Since 1900, Felicity invested one dollar (one time) and succeeded in picking the best performing investment class every year. Today, she would be 110,000 times richer than Bill Gates (For those who are curious, she would have $9.6 quintillion – 96 followed by 17 zeros). It took her 55 years to become a millionaire and 86 years to become the first trillionaire. Over the last century, her incredible gift earned her a 55% average annual return. Even if we take away taxes and trading costs, she would still be worth $1.3 quadrillion (only 14 zeros).
Unfortunately, this perfection does not exist in the real world. The reality is simple – there is no such thing as perfection in this industry. If there were, we would not need thousands of investments to choose from. George Hartman, author of RISK is a Four Letter Word, said it best when he stated that investing is an inexact science: it is better to be approximately right than precisely wrong. As a result, I believe that rather than focusing on trying to find perfection, look to increase your probability of being right more often than being wrong and you will be leaps and bounds ahead of the pack.
Before we get into how to increase your probabilities, lets take a look at Felicity's friend Henry Hindsight. Henry was different because he did not possess the ability to foresee the future. Henry had to resort to strategies much more typical of the average investor. Henry always picked the best performing investment class from the previous year. I call Henry the trend follower.
Unfortunately for poor Henry, his investment strategy led him to poor investment choices. Over the past 50 years, chasing last year's winners led to a loss approximately every other year. Henry's dollar in 1900 is now a mere $783 – a far stretch from Felicity's quintillions. As sad as this sounds, most investors think they can be Felicity Foresight but wind up being Henry Hindsight. The proof is in the fact that last years winners always attract the most money from new investment dollars.
To avoid this very common mistake consider some sound advice:
- Don't Chase Last Years Winners – according to my research, last year's winners have a less than 9.6% chance of repeating performance this year.
- Don't Chase Last Years Losers – On the other side, don't try to go the other direction because chasing last years losers increases your odds of picking this years winners to only 12%.
- Good Research leads to good decisions – Do your homework and look at investments from many different angles. Don't just look at past performance!
- Diversify – Don't just pick one investment hoping that it is the big winner. Diversify your holdings to protect yourself from being the big loser.
- If it's Too Good to Be True – Grouch Marx said it best! Remember that when it comes to investing, there is no such thing as perfection.
- You can't time the market – Felicity could do it but no one else can!