The Misdirection Of Mutual Fund Long Term Track Records

by Neal Frankle, CFP ®

If you want to grow your money for the long-term you should probably avoid buying funds solely based on their 10 or 20 year track record. That’s because it’s highly unlikely that they will turn in a winning track record over the next 10 or 20 years. There are several reasons for this.

First of all, many mutual funds go kaput. According to the Investment Company Institute, 50% of the funds that existed 20 years ago no longer do. They’ve either closed their doors or merged with other funds. There is a 50-50 chance that the fund you have your eye on now won’t even exist 20 years from now.

The next problem is that over the next 20 years any fund you buy is going to go through some very rough patches ahead. No Load FundX did a study last year that reviewed the year-by-year performance of the funds that turned in the best numbers from 1990 through 2012. One fund had an eye-popping 13.6% annualized return and was one of the highest performers during that period. But in 1998 and 1999 it lost money while the market was up over 20%. The fund that did so phenomenally well over the 23 year period, underperformed the market by a devastating 35% in 1998 and 33% in 1999 according to the study. How long would you hold on to a fund that underperformed so miserably over a year or two? You’d probably bail out during the first year….am I right?

This underperformance phenomenon was widespread. Every single fund in the study had a stretch of 1, 3 or 5 long years where the returns were far weaker than the market. That means along the way a lot of investors were shaken out of their positions at the worst possible time.long term track record

And keep in mind that funds do really well under a certain set of conditions like the economy, market and fund manager at the time. But those conditions change. When they do the performance may disappear as well.

In short, long term track records for mutual funds are for the birds. They don’t give you a good basis upon which to make good investment decisions.

A Better Approach

My suggestion is to forget about outperforming the market. Why is that important? I really don’t get it. This isn’t a race. It’s not a competition. What’s wrong with doing as well as the market? Or better yet, what’s wrong with doing almost as well as the market with a lot less risk?

My philosophy is to invest with the least possible risk in order to achieve your financial goals. It makes no sense to take on unnecessary risk. But that’s exactly what you do when your goal is to beat the market. What for? It doesn’t pencil out if you ask me.

There are several ways to invest your money. You can use a buy and hold approach or you can use a market sensitive approach. Each of these tactics has pros and cons. Whichever way you go, focus on your goals first.

Once you are clear about your financial goals, use the investment approach that can help you achieve those goals with the least possible risk.
Is it important to you to beat the market? Why? What am I missing?

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