Sir Isaac Newton’s Revenge on Wall Street

Performance chasing can be tempting.

Those fund managers, stock pickers, and companies who seem to always outperform, always beat, and always return above their peers — well, it’s certainly tough to resist their siren song. Whose first impulse wouldn’t be to get on a train that’s moving quickly, up, and to the right?

But things are not always as they appear, and what comes up must, according to physics, come down. Physics, and Isaac Newton himself, have even more to teach us about the market, as you’ll discover in today’s post.

Sir Isaac Newton’s Revenge on Wall Street

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The third concept, reversion to the mean, is less understood by index fund investors compared to the first two concepts. But it is critically important to understand.

John Bogle writes about reversion to the mean in his book, The Clash of the Cultures. In chapter 9, he offers 10 simple rules for investing, and lists “Remember Reversion to the Mean” as rule number 1. He writes the following on page 301:

“Time and again, I have tried to drive home to investors the need to…rely heavily on low-cost market index funds as the core (or even 100 percent) of their portfolios. Yet too many investors believe that “it’s easy to find funds that have done better, and I know how to do it,” or, “it’s easy to beat the market, so why settle for boring mediocrity.”

They don’t realize how much better off they would be with the boring mediocrity that index funds offer. Sadly, when investors try to beat the market, they select funds that have done well in the past, with the expectation, or at least the hope, that the past will be prologue to the future. But in the world of investing, the past is rarely, if ever, prologue.”

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