Money Listens

Last night I was on Fidelity’s website researching the Contrafund. Guess what information was presented first? Past performance. 1 year, 3 years, 5 years, 10 years. 13.06% for the life of the fund. Sounds pretty good. Guess what comes next. This statement:

Performance data shown represents past performance and is no guarantee of future results.

Yeah, yeah, yeah. But past performance is important, isn’t it? That’s how you choose mutual funds. Get a fund with a good long-term track record.

Surveys show the most important factors people use to select mutual funds are past performance and level of risk.

Economic theory maintains that the most important criterion is future performance and level of risk.

Doesn’t past performance show which mutual fund managers are the best? And shouldn’t those managers’ funds outperform in the future? Unfortunately, no. There is no formula to identify the best managers. Over periods of 10 years only 3/4ths of all stock funds performed better than the market. Past performance can’t be counted on as an indicator of an above average manager. A few years of good results could be the product of chance.

A 2004 study presented a list of stocks from which brokers and portfolio managers chose which stock would do best each month from a pair of stocks. They were only successful 40% of the time, a performance below what could be expected from chance alone. The professionals reported “knowledge” as their main source followed by “intuition”. Evidently, what they “knew” and “felt” wasn’t very helpful when it came to picking winning stocks.

If the professionals can’t predict which stocks are going to perform well in the future, what chance does the average investor have?

This sounds like a great argument for index funds.

Capon, Fitzsimons, and Weingarten. Affluent Investors and Mutual Fund Purchasers. International Journal of Bank Marketing, Volume 12 Number 3 1994 Torngren and Montgomery. Worse Than Chance? Performance and Confidence Among Professionals and Laypeople in the Stock Market. Journal of Behavioral Finance, Volume 5, Issue 3, September 2004 , pages 148 - 153

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