The Pitfalls of Relying on Short-Term Performance: A Guide to Informed Investment Decisions

There is no greater misjudgment for an investor than to base their decisions solely on the performance of the past three years. Allow me to outline three compelling reasons why this approach can be problematic.

(1) Imagine these are the last 3 years calendar returns of a scheme,

2023 - 30%

2022 - 7%

2021 - (4%)

What various websites will show you is,

1 year returns = 30%

3 year returns = 11%

It's important to note that when assessing investments based on point-to-point returns, if the performance over the past year is strong, it can skew the perception of the fund's performance over longer periods such as 3 years, 5 years, 7 years, or 10 years.

Relying solely on one-year returns can be misleading and does not provide a comprehensive measure of the fund's consistency.

(2) Investment Styles,

(i) Indeed, markets tend to follow cycles of 2-3 years, during which specific styles of fund management can thrive. It's crucial to recognize that a scheme that has performed well over the last 3 years may not necessarily replicate its success in the next 3 years, especially when the market cycle shifts to favor a different style of investing. Adaptability and the ability to navigate various market conditions are key considerations when evaluating investment options.

(ii) This is precisely why many investors experience disappointment when they invest in a high-performing fund, only to see it underperform in the subsequent 1-2 years. Market dynamics and investment styles can change, leading to fluctuations in fund performance that may not align with past success. It underscores the importance of conducting thorough research and considering a broader range of factors beyond recent performance when making investment decisions.

(3) Sector & Themes,

(i) In every market cycle, certain sectors and themes tend to perform well, regardless of the overall market conditions, as is the case currently with PSU stocks.

(ii) Many investors often fail to realize that the top-performing scheme they are considering is not necessarily a diversified investment, but rather one that focuses on a specific sector or theme.

(iii) Indeed, the challenge persists that after investors allocate their funds to these sectors, they often find that these sectors have already experienced significant price increases, potentially leading to returns that do not meet their initial expectations.

Relying solely on the past 3 years of returns as the basis for investment decisions can indeed be detrimental to your long-term wealth.