You’ve probably heard from the do-it-yourselfer at your office. “I just invest in the funds with the best performance.” But is this a reasonable? Though a book could be written citing numerous academic studies to address the validity of this “strategy,” I’ll cut to the chase by citing Dimensional Fund Advisors’ (DFA’s) annual study of U.S.-based mutual funds. Let’s answer a few basic questions.
Question: How many stock funds outperform their benchmarks, after costs?
Answer: Only about 26% over a 5-year period, and 14% over a 15-year period.
It’s important to note this study only includes funds that survived during the entire period. In other words, if we counted all the funds that shut down due to poor performance or other reasons, the numbers would look much worse. An older study by Morningstar (2011) revealed that only 54% of funds even survived a full 15 years!
Question: Do funds ranked in the top 25% (top quartile) of funds continue their streak over the next 3 years?
Answer: An average of only 26% of funds per year were able to stay in the top quartile for 3 more years.
There are a lot of reasons someone may consider changing or tweaking an investment strategy. Statistically speaking, recent underperformance of benchmarks is a poor reason. It doesn’t pay to chase returns. Further, chasing returns misses the point of investing. Many investments take time to pan out. Just as underperformance is very often followed by outperformance, outperformance is often followed by underperformance!
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