Does strong past performance mean that a fund will do well in the future?
Simon Brown, Chartered and Certified Financial Planner, explains how it is unwise to pick funds based on their past performance, as they are unlikely to continue to outperform in the future.
Simon Brown, Chartered Financial Planner:
Past performances are not indicative of future results. It is not possible to predict that the previous investment result will be replicated. Some investors select funds based on past returns. However, this chart shows that most US mutual funds in the top quartile, or 25%, of previous five year returns did not retain the top quartile ranking for the following five years. This demonstrates that the past performance offers little insight into a fund’s future returns.
Too many investors are temped into responding to market noise and short-termism, where they will keep making short term investment choices due to previous results. Market activity is too unpredictable to know that a fund will keep on growing following a strong spell. This could be described as ‘investing in the rear-view mirror', which is a short-lived strategy.
Instead of exploiting short term data, it is best to look at the market as a whole and set long term strategic plans using high quality low cost funds for longer portfolio prosperity, no investor should get fixated on previous successes and project that forward to future expected returns.
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