Why is past performance a trap?

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BIG-notorious

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This question has been niggling me for a while.
  • A few people on my other thread commented to the effect that the last 40 years of comparative performance data was meaningless, and I should just invest in a global index so I'm properly diversified.
  • The other day I saw a video on instagram which referenced John Bogle (who I've heard of obviously but haven't read myself) as saying that past performance is a trap and people should just put all their money into the S&P 500.
These statements/recommendations seem totally self-contradictory: they're saying past performance should be ignored and investors should just put their money in Index ABC to capture the market, with the implication (and often outright assertion) being that the index in question will rise inexorably based on.....what else if not the past performance of that index?

This makes total sense in the short term and also for individual stocks. But for different indices in the long term it seems reasonable to assume that differing performance is based at least partially on differing systems and cultures in their originating regions, as well as that countries commercial focus. Competition & consumer law in the EU (for example) seems to make it unlikely that we could produce megacorps like Google.

It also seems unlikely that a four decade long trend is just random. So why does it make any sense at all to ignore decades of performance? Why act like the Nikkei is just as good as the S&P 500 when the S&P has increased by over 30 times in the last 40 years while the Nikkei has only tripled? Or that a global index is better than the S&P 500 when the S&P performs consistently (if only slightly) better the All World?
  • Worse again seems the notion that the Nikkei is the better bet now because it's underperformed the S&P for so long.
Few people would buy a car without doing a history check or finding out something about the brand & model, and people tend to avoid models which are known lemons. You'd be foolish to but a house without checking out the area first. Employers routinely look for references (which OK, are essentially worthless) and previous experience. You go on a date and you want to find out about a person, what they've done etc. People frequent restaurants they like and avoid ones with poor service and food.

Our pensions are for many (certainly myself) their biggest investment decision outside of purchasing their home. But even though we routinely check out the past performance of our cars, homes, restaurants, staff and even our significant others, and then we're told that not only that past performance is not only irrelevant but it's actually dangerous to pay any attention to it when it comes to deciding how our pension should be invested (which again seems like good advice only for relatively short-term investments or individual stocks). Often it's advised to just get the lowest cost global index available.

I'd really like to know why this is. Because honestly it doesn't seem rational to just ignore numbers on long term past performance of indices.
 
What if, as many predict, the US Empire is in it's last minutes and that the US dollar will loose it's reference currency designation in the next 5 to 10 years. Given it's $40 trillion plus national debt will they be able to finance their fiscal deficit as the Chinese and Japanese might no longer buy their junk government bonds ? What do you think happens to US indices when China is the empire in control ? Much of stock market history / past performance figures are based on a period of time since the 1940's when the US Empire was on the rise and at it's peak. This is unlikely to continue so past performance may well be a useless barometer in a changing world order. The Americans are clearly worried given their move to protectionism and their stated need to shift focus from European and Middle East conflicts to the East. I for one am looking wherever possible to reduce my exposure to overpriced US markets.
 
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BIG-notorious said:
I'd really like to know why this is. Because honestly it doesn't seem rational to just ignore numbers on long term past performance of indices.
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It's simply the fact that we don't know the future. Japan could rebound and it's stock market could become a power house in the coming years while the US lags in performance. The point is you don't know, hence why I would agree with Global.
 
Well so far we have saved you a bit of money by casting doubt on your quest to dive exclusively into nasdaq stocks. The nasdaq is down a good bit more in last week or so since you were last posting and especially with trumps tariff shenanigans. Uniquely Europe and rest of world is shaking it off like light rain. I remember during covid European and emerging market stocks were hit very hard but everyone was in love with US tech. With Donald Trump the end of the long affair has happened and Europe looks very attractive again, her long blonde hair is back in vogue
 
BIG-notorious said:
Few people would buy a car without doing a history check or finding out something about the brand & model, and people tend to avoid models which are known lemons.
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It'd be pretty foolish to buy a Ford Capri EV because the 1998 Focus was a good car. That's the kind of past performance trap this refers to.
 
Flybytheseat said:
that the US dollar will loose it's reference currency designation in the next 5 to 10 years
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One of the first results from Google when I input that sentence was an identical prediction in a CBS article. From 2010.

"After years of swelling deficits fed by incessant warfare in distant lands, in 2020, as long expected, the U.S. dollar finally loses its special status as the world's reserve currency. Suddenly, the cost of imports soars. Unable to pay for swelling deficits by selling now-devalued Treasury notes abroad, Washington is finally forced to slash its bloated military budget. Under pressure at home and abroad, Washington slowly pulls U.S. forces back from hundreds of overseas bases to a continental perimeter. By now, however, it is far too late."

The fall of the sky has been predicted many times over my lifetime. It's still there.

It seems even less rational to not only purposefully ignore past performance but at the same time basing a move away from the S&P etc based on predictions of a wholesale collapse of the US economy.
Fortune said:
It'd be pretty foolish to buy a Ford Capri EV because the 1998 Focus was a good car
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My last three cars have been Japanese hybrid imports. That's the kind of past performance it'd be pretty foolish to ignore. And my next car is highly likely to also be a Japanese hybrid import.
Savvy said:
Japan could rebound and it's stock market could become a power house in the coming years while the US lags in performance. The point is you don't know, hence why I would agree with Global.
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So it comes to risk tolerance again? Better off sacrificing higher potential return in return for enjoying an average return regardless of how mediocre the average might be?

Japan has negative population growth while the US has positive population growth. The US & Japanese population pyramids look very different. Those factors alone should from their current starting points virtually guarantee that the US economy outperforms the Japan economy over the next few decades. (But hopefully the Japanese will anyway continue making their cars which I like very much!). Similarly, the US seems to have the highest population growth amongst developed nations which (along with it's current population- third largest on the planet- and GDP) also gives it a big head start in terms of economic growth.

We don't know the future, but there are things about the present and the past that we do know though and shouldn't ignore. Past performance is one of them in my opinion. Otherwise we truly are just monkeys throwing darts.
 
BIG-notorious said:
So it comes to risk tolerance again? Better off sacrificing higher potential return in return for enjoying an average return regardless of how mediocre the average might be?
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But how do you know where that higher return will be over say the next 10 or 20 years?
 
It's simply risk vs reward.
The global index is less risky because "it's more diversified". True but the real magic, is that because it's invested in everything, you never miss the winners. By it's nature the global index can never be 1st on the performance chart (because obviously some constituent of the index will outperform) but will consistently come 2nd/3rd. For the past 10 years, 1st place has gone to the US. Will it be for the next 10? who knows.
By consistently coming second the global index give you high reward but with lower risk.

If next year Indonesia, finds Unobtainium and goes on to outperform all other markets for the next 20 years, with the global index you're covered.
 
BIG-notorious said:
Japan has negative population growth while the US has positive population growth. The US & Japanese population pyramids look very different. Those factors alone should from their current starting points virtually guarantee that the US economy outperforms the Japan economy over the next few decades. (But hopefully the Japanese will anyway continue making their cars which I like very much!). Similarly, the US seems to have the highest population growth amongst developed nations which (along with it's current population- third largest on the planet- and GDP) also gives it a big head start in terms of economic growth
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This analysis is much better than just deciding that an index will do good because it did before.
 
@AJAM

That suggests that the future is not in any way dependent on/ connected with the past or the present. Which is only true if you're rolling a fair dice.

@Fortune

Just because I consider it a big factor doesn't mean i think past performance is the only factor in fund choice. But excluding the past from informing decisions on the future seems very unwise!
 
BIG-notorious said:
It seems even less rational to not only purposefully ignore past performance but at the same time basing a move away from the S&P etc based on predictions of a wholesale collapse of the US economy.
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I wouldn't agree. Rational is assessing current circumstances and the geo political environment and acting appropriatly to those circumstances. Irrational (Osterrich thinking) is asuming what has been true for the last 50 years of 4 billion years of earth history will continue to be true in perpetuity !
 
I'm genuinely not sure if you're referring to Austrian economic theory or large flightless birds. (Osterrich/Ostrich/Osterreich??)

We'll maybe circle back in 10 years to see if the US has collapsed economically etc. The end times have been predicted so often already in my lifetime that I'm guessing not. (EDIT- relying on past performance again...).But eventually they'll be right, it's just a matter of time really.
 
Its a simple question
BIG-notorious said:
I should just invest in a global index so I'm properly diversified.
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BIG-notorious said:
I'd really like to know why this is
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Because stock or index A has strong fundamentals and stock or index B has poor prospects, and this is all reflected in the price.

The US stock market has out performed Japan for decades, yes and its price (PE ratio) is far higher. Maybe the higher price is justified maybe it's not, but the difference in price reflects the opinion of trillions of dollars. You would be a fool to bet against this.

Unless you think that you know the prospects for A and B better than the market, just invest in a global index.
 
BIG-notorious said:
Why act like the Nikkei is just as good as the S&P 500 when the S&P has increased by over 30 times in the last 40 years while the Nikkei has only tripled? Or that a global index is better than the S&P 500 when the S&P performs consistently (if only slightly) better the All World?
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Who exactly acts or thinks like that?
 
Someone on my other thread suggested "you could use European/Japanese/Emerging indexes" for diversification. I also assumed you were also questioning the second sentence you quoted about people preferring global indices Vs S&P 500 even though it's had a small but consistent advantage over the last several decades.
  • There is space between S&P and world index in the last 40 years but there's galaxies between the Nikkei & Emerging Markets over the same timeframe.
 
BIG-notorious said:
That suggests that the future is not in any way dependent on/ connected with the past or the present.
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I'm not suggesting that past performance is not relevant. I'm not even suggesting that past performance is not a good guide. All I'm saying is that past performance does not guarantee future performance.
However the Global index does guarantee, that no matter which geography wins, you're invested in it.

As I said, its risk vs reward. If you only invest in US, you are taking a risk that it will underperform (or out perform). For the last 10 years that risk has been nicely rewarded. And maybe it will be rewarded for the next 10 years. But maybe not.
 
Apparently the best performing market for the last 20 years has been.... Denmark.
So I assume you will be investing 100% of your portfolio there? Past performance etc.
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www.mfpwealthmanagement.co.uk

The randomness of global stock market returns — MFP Wealth Management

It is difficult to predict future returns by looking at the past, as shown by the performance of global stock markets since 2003. A diverse global portfolio can help capture a broader range of returns and deliver more reliable outcomes over time.
www.mfpwealthmanagement.co.uk www.mfpwealthmanagement.co.uk
 
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