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Past performance tells us very little [video]

What factors should we be paying attention to instead?

    The media and many investors often see past performance as a significant indicator of future returns

    But, using past performance to determine if a fund will outperform the market over the long term rarely reaps rewards...

    Jeffrey Ptak, the Global Director of Manager Research at Morningstar, explains further...

    RP: When choosing a fund to invest in, most people tend to focus on how a fund has performed in the past. The fact is that a fund’s past performance tells us very little about its likely future performance.

    Indeed, funds with a good short-term track record — in other words, those you’re likely to read about in the media — are often just the funds to avoid.

    Jeffrey Ptak is the Global Director of Manager Research at Morningstar.

    JP: Whether we’re talking about the media or the investing public, they tend to attach quite a bit of significance to past performance. The question is whether that’s a prudent thing to do and I think the evidence suggests that it’s not. And, why is that?

    It’s because past performance tends to be mean reverting. And so, what we tend to pay attention to, what attracts notice - in the media and more popularly amongst investors - is which has done well. And, which has done well, tends to revert lower. And so that’s the paradox that we face as investors. It is things that tend to speak to us the most, that signal to us the most, to which we are likeliest to succumb to impulse, are probably the likeliest to mislead us because they revert lower over time.

    RP: So, if a fund’s past performance is a poor predictor of future performance, what factors should we be paying attention to? Morningstar’s research constantly shows that a far more accurate gauge is how much a fund costs.

    JP: We have five elements of the research that we conduct, and performance is one of those elements, but it’s a very small element. What we really stress with our analysts who are going out and evaluate and manage investments is, let’s focus more on the things that we think are durably repeatable. Like, the prudence of the process, the depth breadth and continuity of the people, the shareholder friendliness of the parent organisation and then very importantly, the price.

    It has to be priced competitively because one of the things that we’ve seen, if there is anything that’s endured, it’s the importance of price. And certainly, our research has suggested that price is, if not the most predictive variable, certainly close to it.

    RP: The bottom line is that identifying, in advance, an actively managed fund that will outperform the market over the long term is extremely difficult.

    Choosing a low-cost index fund that tracks the whole market will give you a much better chance of a successful investment experience.

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