Investment Hindsight is 20/20: But Where Does That Get You?

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Investment Hindsight is 20/20
Investment Hindsight is 20/20
PART 1: Past Performance Is (Still) No Guarantee

“For time will teach thee soon the truth. There are no birds in last year’s nest.”
— Henry Wadsworth Longfellow

Is there an investor alive who hasn’t heard or seen the ubiquitous disclaimer that past fund performance does not predict future success? The data continue to reveal that this disclaimer remains as relevant as ever. And yet it’s still often ignored. In investing, it’s important to be clear-headed about the facts, lest we succumb to false hope, especially when it comes to considering past “winning” investments.

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Fund managers Dimensional Fund Advisors recently released a research paper, “The Mutual Fund Landscape” to explore the evidence. The paper concludes: “Confronted with so many fund choices—and lacking an investment philosophy to guide their search—some investors resort to picking funds that have strong track records, reasoning that past outperformers will continue to outpace their benchmarks. Does this assumption pay off? The research offers strong evidence to the contrary.”

Dimensional evaluated the track records of stock funds with past “winning streaks,” i.e., funds that outperformed their benchmarks for three, five and seven years, as of year-end 2009. They then assessed how those same funds fared during the next three years, 2009–2012.

    • Funds with THREE-YEAR winning streaks – From the 1,189 funds that outperformed from 2007–2009, nearly three-quarters failed to repeat their wins during 2009–2012.
    • Funds with FIVE-YEAR winning streaks – From the 918 funds that outperformed from 2005–2009, again, nearly three-quarters failed to outperform during 2009–2012.
    • Funds with SEVEN-YEAR winning streaks – From the 597 funds that outperformed from 2003–2009, more than three-quarters failed to outperform during 2009–2012.

On the fixed income side, there were far fewer bond funds with good track records. About 100 funds qualifying for each of the initial three-, five- and seven-year periods ending in 2009. For these, continued outperformance during 2009–2012 hovered between 43–50 percent. In other words, picking funds based on past performance seems at best a coin toss; portfolio-wide, it becomes more of a recipe for failure than success.

But that’s not all. There are additional ways we must keep a sharp eye on the evidence, lest we be tricked – or trick ourselves – into altering the mutual fund landscape. Dimensional’s report outlines two other significant hurdles that make it even more challenging to rely on past performance as a predictor for future success: survivorship bias and expenses. We’ll explore these factors in our next blog post.

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Sheri Iannetta Cupo, CFP®, is Founding Principal of SAGE Advisory Group, based in Morristown, NJ, an independent, Fee-Only Registered Investment Advisory firm, specializing in providing busy professionals and their families with holistic financial life planning and investment management services. You can find more here: www.sageadvisorygroup.com where this post originally appeared. You can also connect with Sheri on Twitter, Google+ and LinkedIn.

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