There are people in this country that make 401(k) investments by bringing up a comparative chart of the last year, three-year, five-year, and ten-year performance, and then making automatic paycheck contributions based on what had been the hottest performers over that period of time. If you don’t enjoy spending a lot of time thinking about investing, it has a certain intuitive appeal: Why not go with the five letters that can report 10% annual returns from 2004-2014 rather than the five letters attached to a 3% annual return?
The problem is this: you could performance-chasing. A fair amount of time, the reason why a particular mutual fund has done well is because the P/E ratio of the type of companies in the fund have increased, and/or the profits have grown significantly during that part of the business cycle. Other times, the past performance does act as a resume of sorts … Read the rest of this article!