This is a pet peeve of mine, and I am seeing it more and more as the dot-com crash of 2001 fades into the distance. As I read various money magazines, I see mutual fund companies taking out full page ads touting their 1-, 3-, and 5-Year average annual returns. How they beat the S&P 500 Index or Lipper average to a pulp. Then, in the fine print below, you will always find these required words: ‘Past performance does not guarantee future results’. You know why? Because it’s true.
Sure, I could make up a MyMoneyBlog Alpha, Beta, Kappa, and Zeta Mutual Fund with different holdings, and one of them will probably beat the market too just by the odds. Heck, I have personally beaten the S&P 500 since I started trading stocks five years ago, even neglecting dividends. Does that mean you should trust me with your money? If so, please send it to… Historically, just because a mutual fund has beaten the averages for a recent time period, it does not mean it will in the future. In fact, due to mean reversion it is likely to do even worse than average.
I am not going to go into a whole mutual fund investing lecture, because there are plenty of good books for that. I just wanted to point this out so people will notice it from now on. If you could pick winners based on simply their recent performance, we’d all be rich. The mutual fund marketers are simply playing to human pyschology which expects such trends to continue. Research says it doesn’t. If you’re going to buy a mutual fund based on a colorful magazine ad, please let it be an ad for a low-cost index fund!