Snapshot Performance

As I look outside my window, it's dark, cloudy and pouring rain but just a couple of days ago it was hot and sunny with clear blue skies.  As we all know, the weather is very difficult to predict. It changes not just monthly, weekly or daily but hour by hour.  Weather forecasters do their best in predicting the weather but even they do not have 100% accurate foresight. They use trends and research tools. They use the past to help them understand the future. And in the end it is just a game of probabilities.

Related article:  Three P's of investing

Predicting investments are like predicting the weather

Large Magnifying GlassWe can draw some similarities between the weather and the investment industry:

  • Firstly, both are imperfect sciences. Financial author, George Hartman once said, “It is better to be approximately right than precisely wrong”. I believe perfection does not exist in the investment industry. Instead, successful investing lies in your ability of increasing your probability of being right more than you are wrong.
  • Also, just like the seasons come and go with some regular pattern, markets can show some long-term patterns too. Markets goes through cycles, which includes ups and downs. Unfortunately,it is the timing of the ups and downs that is impossible to predict. When it comes to predicting the future, market timers have a tough task ahead of them.
  • And finally, just like the weather can change very quickly, so can the market environment. We are led to believe that more risk rewards over time. While this may be true in most circumstances, we must also understand that more risk means that the environment can wreak havoc on our investments.

Related article:  Realities of the stock market

Snapshot performance

And so we get to the point of this message . . . looking at the performance numbers we see in the papers can be very dangerous and misleading.

Fund Name 1 Year 2 Year 3 Year 4 Year 5 Year 10 Year
Fund XYZ 33.9 27.7 22.6 23.1 20.3 16.6

In this example, you will find a fund that has provided a compound average annual return of 16.6% over the last 10 years. By any standard, this data is impressive and who wouldn't invest in a investment like this?

Once again I mask the fund's identity because it would not be fair for me to make judgments on whether this fund is good or bad. Rather this fund serves to prove a point.

The data you see here is typical of what you will find anywhere. Many investors use this information to invest thousands of their hard earned investment dollars. The problem you see here is this data is based on snapshot performance (one ‘snapshot' in time).

You see, any return is calculated based on two points in time: a start date and an end date. What happens in between is not reflected in these numbers. A change in the start date or the end date can dramatically change the outlook of this investment. Even a shift in one single day can have the power of changing these numbers dramatically. In the industry we call this start date and end date bias.

Fund Name 1 Year 2 Year 3 Year 4 Year 5 Year 10 Year
Fund XYZ 37.1 31.5 28 24.7 20.3 15.6
Fund XYZ 9.2 16.5 17.7 16.7 13.1 13.6

Here we have the same investment but two different pictures. How can that be? Simple! Two different snapshots in time (and they are only months apart). End and start date bias usually has a more dramatic affect on the short-term numbers but a 2% difference over 10 years is a significant difference.

The moral of the story

As an investor you must be careful about how you use snapshot performance numbers to judge the merits of an investment. Looking at the typical data you see on a daily basis can be very misleading and dangerous because these numbers can change as quickly as the weather.

Related article:  How do you judge performance?

Don't pick investments based on one snapshot in time. It's not unlike the weather. You might look outside on a hot summer day when the sun is shining bright but within days and even hours, the weather could change and  it could be windy, raining and cold.

Written by Jim Yih

Jim Yih is a Fee Only Advisor, Best Selling Author, and Financial Speaker on wealth, retirement and personal finance. Currently, Jim specializes in putting Financial Education programs into the workplace. For more information you can follow him on Twitter @JimYih or visit his other websites Group Benefits Online and Advisor Think Box.

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