Why a Good Track Record Is Not Always a Good Investment

In his best-selling book on economic and social philosophy, The Black Swan, Nassim Taleb tells the famed story of the turkey. Every day, the turkey goes out from the coop into its enclosure and, lo and behold, there is food. The more the turkey eats, the more food the farmer brings. With each new day, the turkey becomes increasingly more convinced that its enclosure is paradise and the farmer its faithful servant. Then, one day, the farmer comes out to meet the turkey not with food, but with a hatchet. And, before the turkey realizes what’s happening, it is slaughtered, cooked, and served up as dinner for the farmer.

This story is a classic example of what many people do in all aspects of their lives–predict what will happen in the future based on what has happened in the past. But, unfortunately, this approach does not always work. In Taleb’s own words, “Consider that the turkey’s experience may have, rather than no value, a negative value. It learned from observation, as we are all advised to do (hey, after all, this is what is believed to be the scientific method). Its confidence increased as the number of friendly feedings grew, and it felt increasingly safe even though the slaughter was more and more imminent. Consider that the feeling of safety reached its maximum when the risk was at the highest!”

There are fewer areas in which people are more likely to use this method of judgment than in investing. In fact, Taleb is by profession an investment banker and has written much on the errors of track record based investing. “History is doomed to repeat itself,” we’ve been told. And, that may be true. But it is only true in so far as the context is repeating itself. The moment a single variable changes that could affect the performance of any given portfolio is the very moment that the farmer emerges with the hatchet in hand.

In his book Unthinking, author Harry Beckwith tells the story of American donut icon Krispy Kreme. An American tradition since 1937, the company first went public in 2000. Five years later, the stock price plummeted and the company had lost 80% of its value. An investor of $10,000 in 2000, Beckwith explains, will have gotten a return of $620 today. Krispy Kreme’s then CEO attributed the losses to the contemporary diet craze, though most analysts were skeptical of such an explanation. Regardless of the reason for the company’s demise, the key point is that even such a long-standing American enterprise as Krispy Kreme can go bust at the drop of a hat. Rome may not have been built in a day, but it sure doesn’t take much more than a day for it to burn.

The key for savvy investors is to always be vigilant as to what the market is doing. Never let your guard down. Never blindly commit to a particular stock, industry, or portfolio. Don’t sell every time you see the slightest dip, of course, but don’t hold on to investments because they have succeeded traditionally.

Keep your eyes open. Anticipate what’s going on in the market. Don’t be a turkey.