Why Investing Based on Past Performance Is a Terrible Idea
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Both the SEC and FINRA require performance-based advertising and sales literature to include the statement: “Past performance does not guarantee future results.” Is that good advice?
Research by S&P Dow Jones on the persistence of mutual fund performance shows why this warning label makes sense. Of the domestic equity mutual funds that performed in the top quartile for the year ending June 30, 2019, only 53.6% remained in the top quartile in the subsequent year – almost a coin flip. By June 30, 2021, only 4.8% remained in the top quartile.
Expanding the definition of success to simply beating the median fund’s return didn’t help. Fewer than 19% of the top-half equity funds managed to stay in the top half through June 2021.
Widening the time horizon to five years makes the picture even bleaker. Only 2.4% of the domestic equity funds in the top quartile for the year ending June 30, 2017, remained there each year through June 30, 2021. Only 11.0% of the domestic equity funds that performed in the top half for the year ending June 30, 2017, remained there through June 30, 2021.
Another way to view persistence of performance is to examine fund performance compared to a relevant benchmark. For the year ending June 30, 2019, only 628 out of 2,194 domestic equity funds – 28.62% of the total – beat the S&P Composite 1500 Index. By June 30, 2020, only 398 of those funds still beat the benchmark. By June 30, 2021, only 98 of those funds beat the benchmark – 4.5% of the original universe of 2,194 funds.