Does looking at a mutual fund's track record over the last five years help to predict its future performance? Research by Dimensional Fund Advisors shows this approach offers little insight.
Dimensional looked at mutual fund performance over rolling periods from 2012 through 2022. Each year, funds were sorted within their category based on their previous five-year total return. Let's call the top performers — those ranked in the top 25% — the "rear-view-mirror funds."
Did the "rear-view-mirror" funds continue with strong performance over the following five years? Nope. As the chart below shows, few continued their hot streak.
The exhibit below shows that among equity funds ranked in the top quartile based on previous five-year returns, a minority also ranked in the top quartile of returns in the following five-year period.
Percentage of Top Ranked Funds That Stayed on Top
Source: Dimensional Fund Advisors. See notes below.
A lack of persistence casts further doubt on the ability of managers to consistently gain an informational advantage on the market. Some fund managers might be better than others, but track records alone may not provide enough insight to identify management skill. Stock and bond returns contain a lot of noise, and impressive track records may result from good luck. The assumption that strong past performance will continue often proves faulty, leaving many investors disappointed.
A better approach than the futility of trying to predict future winners? Utilize low-cost funds that closely track the market's performance. That's our strategy, which we call Value Added Indexing®. We use these types of funds to construct portfolios based on clients' unique circumstances, taking into account time horizon, need for liquidity, and risk tolerance.
David Rappaport, CFP®
David is the Co-Founder of Rappaport Reiches Capital Management. He acts as personal CFO to entrepreneurs and corporate executives, providing organization and clarity in their finances. Please connect with David below. He loves to talk about investing, financial planning, and Aspiritech, a non-profit hiring individuals on the autism spectrum.
The author does not intend to provide investment, legal or tax advice as these materials are for general educational purposes only. Please consult your legal, tax or investment professional for advice on your particular situation. This material is derived from sources believed to be reliable, but its accuracy and the opinions based thereon are not guaranteed. It is not intended to be a solicitation, offer or recommendation to acquire or dispose of any investment or to engage in any other transaction. Investing involves risk including the possible loss of principal. Past performance does not guarantee future results. Please refer to RRCM’s Form ADV Part 2 for additional disclosures regarding RRCM and its practices.