These days it’s easy to find out what mutual fund or index fund is doing good, performance wise. Providers like Morningstar and Lipper produce ratings for free, or at a nominal cost for more detailed information if you are an investor or potential investor.
Financial magazines like Money and Kiplinger Personal Finance and newspapers like the New York Times, Wall Street Journal, Investor’s Business Daily, Washington Post and other well-respected newspapers provide stories with titles like “The Ten Best Funds for Retirees” and other similar articles and lists.
These articles and lists are based on past performance and we call that the name of this blog, Investing in the Rear-View Mirror. Repeatedly Morningstar, the granddaddy of investment analysis and producer of one to five-star ratings tells its readers that the ratings are for past performance and have no value for estimating future performance. I suspect many readers put faith in four and five-star rated funds and indexes because it’s the only information they can understand.
Additionally, fund companies themselves and custodians like Fidelity or Schwab provide these ratings from Lipper or Morningstar so investors can fall into trap of thinking past performance means the same for future performance.
Morningstar did add a service a few years ago to predict the future performance of securities using a gold, silver, bronze, neutral and sell scale. The jury is still out since they have not completed a ten-year run which would demonstrate their reliability.
Research over the years details that lack of prediction for future performance based on past performance for higher rated funds. In fact, one study showed that picking three-star funds over a ten-year period could be a more successful strategy than picking the higher rated securities.
So, what is the best predictor of future performance which is what every investor should want? No one really knows. The stock and bond markets defy reliable predictors because of the human emotion is known as emotion. It an unknown factor that was highlighted by the latest results of the US presidential election.
To date, low costs and diversification seem to be the most reliable predictors of reasonable performance and lower volatility. If you’d like to read more of these studies just email us at email@example.com.
In the meantime, be wary of these well-intentioned stories and reports. As usual, it’s buyer beware. Do your homework and then stay the course. You’ll be glad you did, the research says.