This is a guest post by Damien Olenslager of bitesizeidea.com.  If you like what you see, you can subscribe to his RSS feed or download his free ebook, The Minimalist Guide to Investing.

How many times have you seen or heard this statement: “Past Performance is No Guarantee of Future Results”? It’s seemingly everywhere in the financial world: magazine ads, TV commercials and every investing prospectus. So why do we ignore it?

It’s the disclaimer put at the end of an amazing sales pitch, where the enthusiastic salesman tells you that over the last 10 years his stock fund has averaged a 34% return. “Invest now! he says, “Our proven track record demonstrates our superior ability to pick winning stocks!” Then, at the end, in tiny print and super-speed-reading voice, comes the familiar phrase, “Past Performance is no Guarantee of Future Results”.

Invariably, lots of people jump on the hot stock solely for the reason that it has a great past performance. The main selling point of these hot stocks directly contradicts the disclaimer they are required to cite.

And these investors get hurt, because it’s true that past performance is no guarantee of the future, in fact, often it is a poor indicator of future performance. Why do I say that? Here are three reasons why chasing hot stocks will make you poorer:

1) Deceptive Returns

Often, when a salesperson claims to have an awesome 10-(or 15- or whatever) year track record, in actuality, their record is usually a series of sub-par or poor returns mixed in with 2 or 3 years of extraordinary returns. One lucky year can make up for several years of under-performing a comparable index.

Conversely, one bad year will wipe out all of those returns that beat the index.

2) Retirement Comes Someday

That fund manager responsible for the awesome 10-year return is probably not managing the fund anymore. 10 years of management is quite a long time; people come and go quickly nowadays.

Perhaps another company offered your wunderkind higher compensation to manage their fund. Perhaps the fund manager’s boss moved him to take over an under-performing fund. Maybe your star stock picker retired.

However it happens, there is a very good chance that the person managing your hot fund with such skill (or, I would argue, luck) has moved on.

3) Reversion to the Mean

Mean reversion is a statistical principle simply meaning that stocks prices fluctuate above and below an average price. After a period ( a few years) of over-performing, the stock will go on to under-perform for an equivalent amount of time. Don’t believe me?

According to The Boglehead’s Guide to Investing,

During the period 1985-2004, no one segment of the market led the pack for more than four consecutive years…And often, as per RTM (reversion to the mean), one year’s leading asset-class performer ended up at or near the bottom of all the other asset groups in the following year or years.

In other words, a stock that’s had a hot streak is probably headed for a few years of less-than-average returns.

What to Do?

Well, now that we’ve seen how picking hot stocks makes us poorer, what can we do about it? What do we invest in so that we get good returns without the headache of chasing hot stocks only to see them under-perform?

Choose index funds!

Damien Olenslager recently graduated debt-free from college and now helps small businesses use technology. At bitesizeidea.com he writes about business, personal finance and wellness from a minimalist perspective.  Download his free ebook, The Minimalist Guide to Investing.