behaviour
Regression To The Mean
The rule
Extreme results usually drift back toward the average. So today's chart-topping star fund reliably lets you down next, like a wet day after an unusually dry one.
Where it flips
Misused, this can make you dump a genuinely good, lasting performer just because it is high, or expect every strong company to weaken. So separate skill from luck first. Regression pulls back the lucky extremes, but a real, repeatable edge is exactly what does not fully fade.
When luck plays a big part in a result, the very top of any ranking is usually people who were both good and lucky. Next time, the luck is gone. So the fund that topped the charts last year is, on average, more likely to slip than to repeat. Chasing last year's number one is chasing the luck, not the skill. And the average is where extremes get quietly pulled back.
A worked example
Haridya moves her SIP into last year's rank-one share fund. Over the next two years it drifts back to the pack. The money she chased out of earns her nothing extra. [illustrative]
How to spot it
- ·buying last year's number-one performer
- ·'it's the best, so it'll keep winning'
- ·a hot streak assumed to carry on
Nassim Nicholas Taleb · Fooled by Randomness