The Past Performance Of A Mutual Fund Is Not An Indicator Of Future Outcomes ... 96% Of The Time
It's almost impossible to ignore past performance when picking a mutual fund to invest in. Indeed, past performance is often the first thing a mutual fund will reveal about itself.
"The phrase 'past performance is not an indicator of future outcomes' (or some variation thereof) can be found in the fine print of most mutual fund literature," writes Aye Soe, Director of Global Research & Design for S&P Dow Jones Indices. "Yet due to either force of habit or conviction, investors and advisors consider past performance and related metrics to be important factors in fund selection."
Because of the way our brains our wired, we often believe that a mutual fund that did well in the past should therefore do well in the future.
But that's a mistake.
Soe reviewed the performance of 687 actively managed domestic U.S. equity mutual funds.
"Very few funds can consistently stay at the top," writes Soe. "Out of the 687 funds that were in the top quartile as of March 2012, only 3.78% managed to stay there by the end of March 2014. Further, 1.90% of the large-cap funds, 3.16% of the mid-cap funds and 4.11% of the small-cap funds remain in the top quartile."
In other words, past performance was not an indicator of future outcomes 96.22% of the time.
Less than a quarter of the top performing funds were still at the top in the next year.
Prospective mutual fund investors often use their own lack of investing knowledge as an excuse for relying on past performance as an indicator. However, they might actually be better suited by just throwing a dart a list of mutual funds.