“Past performance does not necessarily predict future results.”
And it means exactly that—just because something performed well previously does not mean that it will perform that well in the future. That’s the nature of all investments.
Because investments and investment accounts are highly complex, it’s vital to understand not only the investment, but how it’s being presented and in what context. You must understand the context of the performance claim before considering investing or working with a particular broker dealer. Companies are required to provide detailed financial information which can reasonably be relied on by investors. Unfortunately, too frequently, companies are misreporting their financials or prior success to bolster its performance or stock price.
Performance Claims in SEC Filings
The SEC recently issued an investor bulletin warning about performance claims for investments. In it, they discuss several points that must be considered prior to making any decisions, especially how these performance claims are calculated and presented.
- Fees and expenses. How much does it cost to have this investment? Once you learn this number, you’ll need to know if it was included in the performance calculations. Charges for fees and expenses always affect any returns from an investment. Ask if the fees and expenses were included in the calculations, and if not, what they would have been and how performance would have been affected if they had. The SEC references a previous investor bulletin on the subject.
- Your financial situation. This includes variables such as an investor’s age, income, investment objectives, debts, and other investments you already have that might affect your risk tolerance. Also included are your financial circumstances that aren’t taken into account with a performance claim presentation.
- Market and economic conditions. This is where previous performance really does not predict future results. What worked in a prior market may not work well in a current or future market. For instance, performance may differ greatly when interest rates fall as opposed when they are higher.
- Another important point is to find out how the performance claim is calculated. The bulletin states, “Factors such as how a performance calculation accounts for dividends and its assumptions about taxes and market and economic conditions are important to understanding performance calculations.”
Reliability of Reported FInancials
The SEC also recommends considering these variables to evaluate the claim’s reliability.
- Guarantees, targets and projections in performance. There are no “guarantees” in investments. There is simply no way to guarantee anything with market risk involved, such as stocks. Projections and targets are hypothetical, and can’t be used to predict future performance, and may give unlikely outlooks for performance in the future.
- Back-testing. This is a method that takes an algorithm that’s applied to previous market conditions to show how an investment may have performed in that market condition. This, too, is hypothetical, and is also not an indicator of how something would perform now. The SEC points out that, “If you receive back-tested performance, you should consider asking what actual, historical performance was.”
- Past performance is, of course, how an investment did previously. But as we’ve stated, past performance is not an accurate indicator of how an investment will perform in the future.
- Past Performance: Cherry-Picking. Instead of giving a complete picture of past performance, the company “cherry-picks” the good performance and leaves out less than stellar performance. Past results should include both up and down markets over a reasonable period.
- It’s important to understand a comparison of “apples to apples,” so the SEC recommends using one to judge the investment’s performance against a specific benchmark. Remember that the benchmark may not consider any fees and expenses, which can lower your returns.
While a performance review can be an important part of due diligence, it should not be the only one. You should understand the performance review and how it was created and presented so that you can adequately appraise the consistency and trustworthiness of the company’s claims.
As always, if the claims do not seem believable, or are too difficult to understand, chances are you may be seeing something that isn’t what the company claims.
Did You Invest Based On Bogus Financial Reports
Silver Law Group represents investors in securities and investment fraud cases. Our lawyers are admitted to practice in New York and Florida and represent investors nationwide to help recover investment losses due to stockbroker misconduct. If you have any questions about how your account has been handled, call to speak with an experienced securities attorney. Most cases are handled on a contingent fee basis, meaning that you won’t owe us until we recover your money for you. Contact us today at (800) 975-4345 and let us know how we can help.