Everything looks good in hindsight

David MoonBlog

I have developed a 100% foolproof method for reaching your ideal body weight. No one has ever failed using my system; every person using Moon’s Miracle Body-mass Management Method has succeeded in reaching and, more importantly, maintaining his ideal body weight. Here is the secret: over five years I studied people who exercised vigorously daily, ate healthful foods, consumed only enough calories to support their ideal body weight and got plenty of rest. At the end of the five years, every individual in the study was the perfect weight.

One caveat: every three months we dropped from the study anyone who missed a workout or cheated on his diet. Otherwise, the system worked perfectly.

Don’t laugh. Investment promoters regularly use similar back-tested, survivor-biased models in creating and selling investment products. After you complete a questionnaire, your adviser might determine that his firm’s Conservative Growth and Moderate Exposure (shortened: Con Game) portfolio is perfect for you. The portfolio holds eight different mutual funds that averaged a 15% annual return over the past decade, with no down years. What the salesman might not clearly communicate (that is, buried in six-point font on page 73 of a document you never read), however, is that his firm routinely changes the funds in the Con Game portfolio; the current funds – those with the outstanding historical performance – are almost certainly not the funds owned in the last few years by other investors in the Con Game portfolio.

Consider the indexed ETF industry. A new ETF cannot tout hypothetical performance. A company can, however, promote the hyper-successful, hypothetical, back-tested results of a newly created index. An investment firm can then start a new ETF designed to track the new index, touting the hypothetical returns of the index – not the ETF. By sifting through enough historical data, stock promoters can inevitably find some pattern that would have never produced historical outperformance – data that is useless for predicting the future.

Never underestimate a greedy person’s creativity in separating you from your money.

Even the use of actual mutual funds returns can be used to mislead and sway you. When a 401(k) sponsor is trying to convince you to hire him to manage or administer your retirement plan, you can be assured that the investment options included in the menu have outstanding recent performance. Of course, the funds the broker proposes to you may be entirely different than those he showed a prospect a year, or even six months ago. When a broker has an almost unlimited number of funds in his pantry, he can always show a prospect the ones that recently performed best, implying that his existing clients earned those returns.

(“Armageddon Fund” cartoon by Harley Schwadron.)

David Moon is president of Moon Capital Management. A version of this piece originally appeared in the USA TODAY NETWORK.