You dont drive looking through the rear-view mirror nor should you invest by looking backwards at past returns.

Investors often fall into the trap of allocating their funds based on the recent outstanding performance of a particular investment.

In the same way objects in the rear-view mirror appear closer than they really are, our perception of recent performance is able to be magnified out of proportion. But in the investment market, past performance is no reliable indicator of future success.

Chasing hard work for less return

Imagine you had $10,000 to invest in January 1988. Establishing a well-diversified portfolio would mean that your investment increased in value to $51,768 by December 2008.

Alternatively, you could chase returns by investing in whichever asset class produced the best results over the previous year. Your investment would be valued at $37,074 over the same period, without even taking into account the costs of switching.

The only certainty in investing is change

Changing economic conditions affect the performance of companies. Share price fluctuations affect the performance of managed funds with market-linked investments. And the overall performance of a particular asset class can be affected by local or international financial trends.

Sometimes less obvious events have implications on an investments value. For example, what if a successful financial team leaves for another investment house, causing the leading fund manager to fall back to the pack?

The past a roadmap for the future?

While past performance shouldnt be ignored completely, it doesnt give us the complete picture of an investments future performance. You also need to look at the underlying quality of the investments that make up your portfolio.

Rather than concentrating exclusively on a companys recent share price, look at factors that might affect future performance such as its earnings outlook and overall sector trends.

Similarly, it pays to take a holistic approach when comparing the performance of a managed fund. Take into account factors such as funds degree of diversification and the credentials of the investment managers.