Avoiding Misleading Investment Sales Pitches: A Cautionary Guide
Written on
Understanding Investment Pitfalls
It's all too easy to make poor investment choices when you place too much trust in irrelevant data. A prime example is the reliance on past returns when making investment decisions.
Many sales pitches for investment opportunities emphasize impressive historical returns, but in reality, this metric is often misleading. This article will clarify why "past returns" should not be a cornerstone of your investment strategy, as it can lead even seasoned investors to make regrettable choices.
The Illusion of Past Returns
When it comes to index funds, comparing past returns is particularly pointless. For instance, if two funds track the S&P 500, their performance will be nearly identical, making past performance comparisons irrelevant.
Consider two S&P 500 index funds:
- Fund A shows an annual return of 37.7% since it started in February 2020.
- Fund B reports an annual return of 70.1% since it launched in March 2020.
At first glance, Fund B seems superior. However, the difference arises from timing. Fund A debuted just before the Covid market crash, while Fund B opened right as the market began to recover. Despite Fund B's eye-catching returns, this historical performance has no bearing on potential future earnings or its viability compared to Fund A.
Since index funds essentially serve the same purpose, your best strategy for maximizing returns is to select the fund with the lowest fees. Unfortunately, many investors overlook this principle, drawn instead to misleading figures like "past performance."
A 2010 study involving 730 participants revealed a common trend: individuals consistently chose funds based on historical returns rather than minimizing fees, even when tasked with investing a hypothetical $10,000.
Surprisingly, many participants were Harvard staff and Wharton MBA students, who one might expect to make more informed choices. Although those with greater financial literacy tended to pay lower fees, they still did not prioritize minimizing costs, even when provided with a "cheat sheet" detailing fund fees.
This illustrates just how challenging it can be to resist the allure of misleading metrics like "past returns."
Key Takeaways for Smarter Investing
- Minimize Fees: Always be vigilant about the fees associated with investment funds, particularly index funds. Over time, high fees can substantially diminish your overall returns.
- Look Beyond Past Performance: High past returns are not a reliable predictor of future success, especially for funds that track the same index.
- Enhance Financial Literacy: While it doesn't guarantee success, increasing your understanding of investment principles can lead to improved decision-making.
- Seek Professional Guidance if Unsure: If you find yourself uncertain about your investment options, consulting a financial advisor can be beneficial. Research indicates that less confident investors are more prone to adjust their portfolios based on expert advice.
This piece originally appeared on the Making of a Millionaire Substack, where you can find more insights.
Disclaimer: This article is for informational purposes only and should not be taken as financial or legal advice. Always consult a financial professional before making significant investment decisions.
Don't fall for these 5 Retirement Scams! Buyer Beware!
This video discusses various deceptive sales techniques that can mislead investors into unwise retirement strategies.
Warning: Don't Fall for This Investment Pitch and Text Message Scam Alert
This video highlights common scams and provides tips on how to recognize and avoid fraudulent investment pitches.