Don’t Chase Returns

Very often individual investors choose mutual funds based on the historical performance of the fund. To many individual investors it seems logical that past great performance would only indicate a tendency for future great performance. According to a July 2013 report from S&P, this may not be the case.

Twice a year S&P Dow Jones Indices releases its Persistence Score Card. This reports tracks the consistency of top mutual fund performers over yearly consecutive periods asking the question, does past performance really matter?

The latest report shows that picking a fund purely based on performance is statistically a losing game as very few funds can consistently stay on top. Out of 703 funds that were top performers as of March 2011, only 4.69% managed to stay on top over three consecutive 12-month periods. Looking longer term, only 2.41% of large cap, 4.65% mid cap and 4.65% of small cap funds were able to stay in the top half of their peers over five consecutive years.

So what is an investor to do? When picking a mutual fund you are really picking a fund manager. This fund manager is usually actively trading your money to beat his or her assigned index. They will have good years and bad years but statistically they will not beat their assigned benchmark over the long-term. I recommend that investors look at investing differently.

Here are some keys to a good investment strategy foundation:

• Keep your investment cost low – stay away from commission-based mutual funds and those advisors that sell them. Focus more on index mutual funds and or Exchange Traded Funds (ETFs) that many independent advisors use, or if you are a do it yourself kind, consider using Vanguard funds. Make sure that you also understand how and what you are paying your advisor. Fee structures and the amount that you pay an advisor can vary greatly. All fees lower your return. You will have to decide what is fair for your situation.

• Ignore the short-term focused news cycles. If you are investing long-term, remember that the financial news media is focusing on today or tomorrow. You should not be worried about the next 2 years if you have a 20-year time horizon. Build a portfolio that focuses on long-term healthy asset classes.

• When building a portfolio make sure the portfolio is diversified. Very often we see individuals hold three different large cap mutual funds. They think they are diversified but really they basically hold the same stocks in three different mutual funds. You want to create a mix of bonds, large company, medium company, small company and international stock. How you allocate to these categories will depend on your age or your tolerance for volatility within your portfolio.

• The most important aspect in investing is your financial behavior. Don’t try to time the market or make decisions based on how you feel. Focus instead on the long-term success of investing over any time period. For those still saving, by adding money to your portfolio each month you get the advantage of dollar cost averaging. This allows you to buy in the low times making that money work harder for you over your lifetime.

You can view the S&P report here.

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