Why do investors rely on past performance?
A paper authored by Professor Peter Ayton and Dr Leonardo Weiss-Cohen has featured in a Wall Street Journal article published on 23 July 2021, discussing investor decision-making and past performance.
The Wall Street Journal (WSJ) article discusses the flawed tendency of stock-market investors to base their decisions on the past-performance of stocks, in light of recent Delta variant-fuelled imitation of market activity from the Covid-19 panic of 2020.
The article highlights a paper written by Professor Peter Ayton, Dr Leonardo Weiss-Cohen and Dr Philip Newall (Central Queensland University, Australia) discussing decision-making factors behind investors’ behaviour, specifically their tendency to use the ‘rearview mirror [as a] crystal ball’. WSJ author Jason Zweig explains that the stock-market is a ‘complex, dynamic system’, and relying on recurring patterns, as many do, can lead to devastating losses when they shift or reverse.
The paper discusses their study, which tested disclaimers about past investment performance on 1,600 people (just over 1000 of who had some investment experience).
During 60 rounds of decision-making between investing into Fund A, which offered lower fees (a far stronger indicator of high-performance than past returns) and Fund B, which offered higher fees, the participants were met with one of two statements: ‘past performance does not guarantee future results’ or ‘some people invest based on past performance, but funds with low fees have the highest future results’.
The study found that investors more often chose Fund B when presented with the statement ‘past performance does not guarantee future results’ than when presented with a warning statement: ‘some people invest based on past performance, but funds with low fees have the highest future results’.
This is because, Dr Weiss-Cohen commented: ‘a lot of experienced investors seem to believe that the warning won’t apply to them...it’s maybe like they think, ‘I can make it work, because I know better’. The warning statmement, however, Dr Newall commented, prompted investors to make a social comparison- “who wants to settle for investing like ‘some people?” and choose to invest in Fund B.
The researchers found overall that ‘some people invest based on past performance, but funds with low fees have the highest future results’.