Be wary of five-year performance data

Slick salespeople love to tout past performance data as an inducement to get you to invest. They sound authoritative and knowledgeable when they say, ‘Let me tell you about the Widget Fund ‘ it made 12 percent per year for the past five years!’ And consumers happily follow along. Everybody loves past performance data, despite the fact we are constantly reminded by regulators that ‘past performance does not guarantee future results.’ Obsessing about past performance is an old problem, but it is particularly acute right now. The reason: Performance data for the past five years now refers to 2003 to 2007. The bear market of 2000 to 2002 is no longer considered. You see, when salespeople touted performance data in 2007, they had to refer to the years 2002 to 2006. But when we entered 2008, we dropped 2002 (when the S&P 500 Stock Index fell 23 percent) and added 2007 (when the S&P gained 5.5 percent). What a difference that makes! The new five-year period of 2003 to 2007 makes returns look fabulous: The S&P 500 gained an average of 12.8 percent per year. But if we include the full bear market by examining 2000 to 2007, the average annual return is only 1.7 percent! This is reflected in the best performing stock funds of the last five years: Several made 24 percent a year on average. But their eight-year track records are as poor as minus 2 percent. If someone offered you a fund that has a ‘track record’ of earning 24 percent per year, you’d want to buy it! You wouldn’t want to buy an investment that has lost 2 percent per year, would you? But it’s the same investment! Astonishingly, you don’t have to compare a five-year period to an eight-year period to see this dichotomy. For example, consider one highly popular growth fund. According to Morningstar, for the five years ending Dec. 31, 2006, this fund lost 0.4 percent per year. But when you replace 2002 with 2007, the fund’s record for the five-year period becomes 12.3 percent ‘ an amazing difference! This amazing difference occurs because the fund lost 40.7 percent in 2002 but gained 22.6 percent in 2007. So you tell me: Is this a great fund or a terrible one? We’re worried that a lot of investment advisers, stock brokers and so-called experts who appear on TV and radio touting investments that have great records for the past three or five years. But they fail to disclose how these ‘great funds’ fared over other time periods that might tell a very different story. This is why you must be extraordinarily careful when evaluating investments based on their past performance. If you encounter a stockbroker or an investment adviser who brags about past performance data, walk away or hang up the phone. If you hear some clown on the radio or TV touting prior returns as a reason for investing, change the channel. Target-date mutual funds are getting a lot of criticism. Also known as lifestyle funds and life-cycle funds or ‘L funds,’ they comprise one of the latest fads on Wall Street. These funds offer convenience. Rather than leaving you to figure out your own asset allocation, these funds handle the allocation decision for you. But convenience might not be as valuable as you think. ‘We feel very strongly that target-date investing is just the worst possible thing,’ Compass senior vice president Elliot Fineman told Investment News. Stay away from target-date funds and L funds.