Regression to the Mean

Explanation

Regression to the mean is one of the most powerful forces in investing. The best-performing funds in one year rarely repeat the next. Companies with exceptionally high profit margins attract competition that erodes margins over time. Markets that rise dramatically tend to deliver below-average returns in subsequent years. Understanding this concept protects against two common mistakes: chasing recent winners (performance chasing) and avoiding recent losers (selling at the bottom). Mean reversion is the foundation of value investing and contrarian strategies.