The Fallacy of Historical Returns

Pay phone
February 14, 2017 by Matt McCracken

I stopped to fill up my car at an HEB in San Antonio and, while I was paying $1.99 for gas, I saw the following and thought I must have just traveled back to 1998. 

A pay telephone.  At a gas station.  I hadn’t seen one of those in years.  And it reminded me of an experience I had way back when.

It was either June of ’99 or ’00.  I forget.  I was at an insurance conference in New Orleans.  Who schedules a conference in June in New Orleans except insurance people? 

A guy was going around trying to sell people on his “can’t miss” income opportunity.  He was selling interests in, wait for phones.  And the guy was convincing.  I was with a slightly younger colleague of mine who bought in hook, line and sinker.  I forget the specifics but this guy’s pay phone deal had yielded something like 20% for the past 30 years.  He had audited financial statements to prove it.  I mean this deal was a sure thing.  We counted ourselves lucky that he would even share it with us! 

So my colleague is about to go for it.  And I pull him aside and I say to him.  “Before you invest with this guy, why don’t you ask your dad (who was a high powered insurance executive living life largely on the road) how many times he used a pay phone in the past six months?”  You see his dad had a cell phone.  At the time, cell phones hadn’t proliferated.  Only rich, important people had them.  A lot of people still used pay phones but cell phones were gaining market share quickly thus making pay phones obsolete. 

The kid asked his dad the question while I was still present.  Then I instructed him, “Now ask him how often he used a pay phone 5 years ago?”  He got the point.  But others didn’t and I’m assuming they lost their entire investment.

Financial pundits love to spit out historical returns.  They quote them as gospel.  But the entire notion of historical returns is asinine.  The more something has returned, the more likely it will return less and not more.  The low hanging fruit is already gone.  If someone is quoting historical returns on something, than that something but be expensive enough to no longer be cheap.  The pay phone story is an all-too obvious example of that.