Past Performance and Probability
By Bryan Caplan
Merely looking at past performance of stocks is not a sufficient basis for saying that stocks will outperform Social Security. One of the basic mantras of investing is that past performance is no guarantee of future results.
In response, I’d say that, like most mantras, this one is pretty silly. After all, in the real world, nothing guarantees anything. All we’ve got is probability. And the historic performance of stocks and bonds makes it extremely probable that they will beat Social Security.
But how is this different from those lame mutual fund adds bragging about how well they did last year? The answer is that on average, such funds really don’t do particularly well in subsequent years. So the right warning would not be “Past performance is no guarantee of future results,” but “Past performance does not increase the expected value of future results.”
In fact, the literature on mean reversion concludes that past performance negatively predicts future results. So when you see those lame ads, you arguably learn where not to invest!