We can’t help it. It’s human nature. Our view of how our investments will do in the future is influenced by how they’ve done in the recent past and what the headlines are telling us today. Unfortunately, both factors are poor predictors of what returns will be.
Extrapolating past returns is easy to do, but there’s no evidence that it works. There’s a reason why ETFs and mutual funds carry a warning label — “Past performance does not guarantee future results.”
As for the media, what’s in the spotlight is always interesting, but not always important when it comes to your portfolio. For instance, while Trump, North Korea and Brexit dominate the airwaves, there are hundreds of other factors that will have a bigger impact on long-term returns.
The most reliable factor in determining what returns will be is the starting point. Specifically, the price you pay for an asset, or what’s referred to as valuation. Are you buying at Costco where bargains abound, or the Apple Store where nothing is on sale?
Over longer periods, valuation is the closest thing to gravity that investors have. Stock prices will eventually reflect the value of the underlying companies. But to be clear, valuation is useless in predicting the market’s direction in the next quarter, year or even two years. Stocks can stay cheap or expensive for extended periods.