Yesterday’s news

Posted by on July 17, 2009 @ 8:51 am in investing

Steve Utkus, one of my fellow bloggers, wrote recently about the dubious value of a local radio station’s early-morning reports on where the S&P 500 and Nasdaq markets are likely to open the day, based on futures trading. He labeled it “junk news.”

Since this is a “summer of sequels” at the cinema, I’d like to add my own sequel to Steve’s blog post.

One of our local news stations has a daily feature on mutual funds that highlights the best-performing funds by citing their returns. Frequently, the funds are those that specialize in particular sectors, and their performance is ranked for very short periods of time—usually year-to-date. I’m puzzled by the value, if any, the station’s listeners find in these reports. Is it purely informational (e.g., “That’s interesting; I didn’t know that”), or are people actually making investment decisions based on the report? While I hope it’s the former, I fear that some people may fall into the second group. I wonder what purpose this is trying to serve, and why the “truth in advertising” standards don’t apply here.

This raises a bigger question: Why broadcast fund performance at all? Publicizing a fund’s past performance is like selling yesterday’s newspaper. It’s of little value and provides no insight as to what the news may be the next day. (Now, if we could buy tomorrow’s newspaper today, that would be a different story!)

There are just too many variables to make past performance a reliable indicator of a fund’s future returns. Did the fund manager have a blow-out quarter (good or bad) that’s influencing the long-term numbers? Is a manager with skill being labeled a poor performer because he or she is burdened by a high expense ratio that depresses the performance?

All of this makes the purchase decision for funds that much harder. For many other purchases in our lives, past performance is a good indicator of future performance, whether it’s a car or a washing machine. Not so for investments.

Given the limited value of using past performance as a purchasing guide, how do you evaluate investments in your portfolio?

Note: All investments are subject to risk.

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